Q2 2020 Gap Inc Earnings Call
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Good afternoon, ladies and gentlemen, my name is Christie and I'll be your conference operator today at this time I would like to welcome everyone to the gap incorporated second quarter 2020 earnings call. At this time all participants are in listen only mode for those analyst who wish to participate in the question answer session. After the presentation you May now press star.
After the Q O Q.
Reminder, please limit your questions to one per participant.
Anyway, she require assistance during the call. Please press the star key followed by the zero on your Touchtone phone today's call is being recorded and at this time I would like to introduce your host general Knotty head of Investor Relations.
Good afternoon, everyone. Welcome the gap Inc. second quarter 2020 earnings conference call before we begin I'd like to remind you that information made available on <unk> conference call contains forward looking statement.
For information on factors that could cause our actual results to differ materially from the board.
It's mostly description and reconciliation of non-GAAP financial measures.
<unk>.
Please refer to todays earnings press release.
Well as are most recent quarterly report on form 10-Q.
Nice 2020.
Subsequent filings with yet.
Oh, which are available and got me.
These forward looking statements are based on information as of August 27, 2020, I mean, it didn't do obligation to publicly update or revise or for that.
Joining me on the call today are Chief Executive Officer officers don't get people [laughter], Chief Financial Officer Trina.
I've mentioned.
Using sites to supplement our remarks, which can be back like any investors I've just got stuck.
With that let me turn it over the country.
Thank you cannot thank you everyone for joining us.
To cope with kids Ondeck has been challenging for everyone, including impacting the gapping.
I will discuss.
But more importantly, I want to acknowledge the tremendous affects.
Everyone's lives from a health economic and social.
I can't think we believe strongly and meeting with our values, especially this time.
We hope you and your families are well at healthy, particularly as we recognized the continuing challenges.
For todays call I'm going to start with a review of the company's second quarter performance, followed by our thoughts and the remainder of fiscal year 2020. Following Dobsonian will share my perspective, and then we'll open it up for today.
Before I jump into our second quarter results I watch your thoughts the transition from the first quarter to second quarter.
We've been highly focused on executing stops to ensure liquidity for the company, including addressing the challenges of widespread store closure.
Also recognize we had an opportunity to drive growth spoke through focused investments by leveraging our best in class capabilities to returned the company trade group sales performance in margin improvement I'm pleased to say, we delivered on that in second quarter.
So I'd like to touch on a few highlights.
First driven by the performance of our three strictly before <unk> billion dollar plus brands in combination with the many steps taken across the organization in support of cash preservation of liquidity, we had the best second quarter operating cash flow at least five years.
But the company and it's an excellent financial position.
Second our teams remain focused on driving the fundamentals of the business, but also taking aggressive steps to support the companys financial stability in the midst of Coke in 19.
Our online sales grew 95% compared to Q2 2019, supporting our customers choice to shop, our brands in the channel platform or for not where their most comfortable.
We reopened about 90% of our stores, providing safe places for our consumers to shop any person her card side for the products They love it.
Also significantly improved our inventory position following a turbulent first quarter marked by store closures and we now have inventory levels at more closely align with customer demand.
And lastly, well discussions with landlords continue I'm pleased with the progress we've made towards our goal and the more profitable stores.
Well provide an update today, but we also look forward to sharing a broader longer term update with you during our virtual investor meeting on October 20 seconds.
Now, let me turn to our results in a second quarter total company net sales were down 18%, representing a significant improvement versus the preceding quarter online sales increased 95%, which modestly benefited from shipment timing offset by 48% decline in store sales reflecting store closures.
That began in Q1, followed by meaningfully improved results as stores reopened over the course at the corner.
It's worth noting the company delivered a positive 13% comp in the quarter supported by our scale online business, which represented roughly half of our sales this quarter.
In particular old Navy and that's what I continue to outperform its customers respond positively to their strong product offerings relevant marketing messages.
Second quarter gross margin was 35.1% down 380 basis points compared to last year. This reflects 270 basis points of de leverage in merchandise margin as well as 110 basis point do you ever just rents and occupancy driven by a decrease in natsios largely due to store closure.
As a result at Cobiz Nike.
Merchandise margins, reflecting on favorable impact of higher shipping cost in support of online sale.
Partially offset by product margin expansion due to lower just counting in response to stronger they on for our products across nearly all of our grant.
As we noted last quarter, we serviced a meaningful portion of our online orders through the stores, which is a more extensive fulfillment options this important customer demand.
As we look ahead, we've now better aligned our inventory to the elevated demand in our online channel.
With that shift of inventory by channel and we expect shipping expense, while still higher than last year with continued growth in the channel to moderate somewhat to the second half the year.
Before I first want to ask an exercise and the rest of second quarter results. Let me update you on our focus to improve the profitability our store fleet.
How do you know we're committed to the rationalization of our gap and Banana Republic store fleet as we look to improve the profitability of that was brown.
Well landlord negotiations are ongoing we currently expect to close over 225 gap and Banana Republic stores globally on a net basis 2020 ahead of our previous expectation with line of sight to additional store closures and 2021.
During our virtual Investor meeting in October well be able to provide you with a further uptake, but all set I feel very good about our progress here.
Okay, well, we've talked rent payments on store locations that were required to be close you did a kobin come down that's something we shared with you last quarter. We continued to reflect full rent expense on the all stores in our financial statements as required by accounting practice.
We continue to negotiate with our landlords to approve economics for all parties.
To date, we've negotiated agreements on a number of our leases and more agreements are anticipated over the next several.
Turning to ask today, that's your name them quarter declined by roughly 200 million dollar is driven primarily by reduced store payroll and other store expenses related to closure.
Included in investing in in store safety measures something we love the industry, yet as we welcomed our customers back to our stores.
As a percentage of sales after today was 32.9% 410 basis points higher than a year ago corner as expense reduction was more than offset by lost sales from couldn't really to store closures. So from an EBIT standpoint, with our group sales performance versus the first quarter and tight expense control the company delivered.
Second quarter operating income $73 million or 2% to sale.
As discussed during our first quarter earnings call. The company redeemed the one in the quarter billion dollars in the unsecured notes due to mature in 2021, that's part of a refinancing reflecting the issue and update you in a quarter billion dollars of senior secured notes.
Retiring the 2021 notes the company incurred at 58 million dollar make whole premium discharges nonrecurring and classified as a loss on extinguishment of debt on the income statement.
Aside from the nonrecurring charge second quarter net interest expense was $56 million.
One thing increased interest expense as a result of our new financing.
We expect net interest of approximately $55 million per quarter on a go forward basis.
Yeah, that's just tax rate for the quarter with the negative 51%, which reflects changes in the estimated benefit associated with the enactment of the care that due to the company's strong performance in the second quarter and the impact from the geographical mix a pretax earnings.
Our year to date effective tax rate was 23.5%, which represents a more normalized rate given the impact of earnings variability I care that benefit on the second quarter.
Earnings per share with a lots of 17 cents a significant improvement from the first quarter.
Turning to the balance sheet on a reported basis, we ended the quarter with inventory down about 4% recall as part of a disciplined approach to managing inventory in the face of uncertain demand, we implemented a pack and hold inventory approach whereby the last summer product is being held and will be released during next year selling season.
As a result pack and hold inventory will remain in our reported inventory numbers until the same time next year.
End of quarter enough inventory, excluding pack and hold was down about 10%.
Looking ahead, we continue to expect inventory, excluding pack and hold to be down mid single digits for the remainder of the year.
Let me turn to cash flow.
As we discussed last quarter fundamentally got because a strong cash flow generator with over 10 plus consecutive years of at least a billion dollars operating cash flow.
Our second quarter operating cash flow is a testament to the cash generating power of our business.
Well, we took important steps to preserve liquidity is outlined last quarter. The strong cash generation. We saw in second quarter was largely a result of improved sales performance overall with new financing plus strong operating results. We ended the quarter with a cash balance of $2.2 billion.
Year to date capital expenditures were 208 billion dollar for the full year, we continue to expects capital expenditures of approximately $300 million with the majority of spend oriented towards technology and supply chain investments that support changing customer shopping habits and are aligned with our strategic intent to create.
Seamless journey for our customer across any touched paid point that she engages bad weather in our stores on our site using our hopper through social media.
And lastly, before I turn it over Sonia let me give you some thoughts on the remainder of the year.
Given the high level of uncertainty in the current environment, we're not providing fiscal year net sales our earnings outlook at this time.
However to be helpful. Let me provide some thoughts on the back half.
First we expect net sales to continue to improve versus the second quarter, reflecting a meaningful online sales growth coupled with continued recovery following their pre opening of our stores.
We expect our sales performance to be fueled by continued strength at old Navy and Athleta, partially offset by revenue loss from strategic closure of unprofitable stores as well as the potential for continued weakness banana Republic.
Second as it relates to expenses, it's important to note that we will continue to face higher operating costs as we serve our customers during the pandemic.
In particular, we're now applying our best in class Dorothy measures tour largely related to sleep, resulting in meaningfully higher store expenses during the first half.
In addition, we continue to expect higher shipping expenses as online growth is expected to outpace last year.
And lastly, we are strategically investing in marketing behind our brands as we focus on gaining share and this disruptive environment and at a time when trusted brands matter.
As we look to the back half would be on we remain committed to amplifying are distinct advantages and scale to capture demand and gain share, including leveraging our scale and advantaged omni capabilities across our stores and E commerce.
Harnessing the power of our brands, an enviable customer file to drive loyalty engagement and frequency.
Leading to our values at a time when trust matters and continuing execution of our initiatives to drive profitable growth through streamlining our operating model and sleep optimization.
Look forward to discussing there with you at our Investor meeting in October and with that I'll turn the call over Sonya.
Thank you Katrina couldn't ask for a better partner and good afternoon, everyone.
So to speak with all of you today in a very different positions in last quarter.
We began Q2 with all North America stores close to customers and we ended the quarter growing sales and improving profitability.
As we pivot to off and I'm encouraged by three things first.
First fundamentally our business is healthy and I'm proud of what the teams delivered in Q2 I will share more on this shortly.
And despite uncertainty ahead I'm confident that our unique strengths are powerful brands, our size and scale a relevant product in our omni capabilities are helping us win now and will position us well for the back half and well supports this company in any environment going forward. This.
It is important as it will allow us to take share as the apparel market reshaped itself.
And third the long term potential for gapping in our brands is significant we've been highly focused on crystallizing, our strategy and plans for value creation, which we will look forward to sharing with you in October.
Let me touch on each of these.
We feel great about our performance in Q2, and our customers loyalty to our powerful purpose driven brands.
Really proud of our teams for rising to the challenge I relentlessly driving for growth, making opportunistic moves in crisis and tightly managing cash flow to build financial resilience.
The showed up at our topline with online sales nearly doubling versus last year driven in part by year over year growth in our acted and sleep businesses, which in Q2 make up about 24% total sales we won in the value basis, maybe only one of the premium space with that let us and it's very important category at this.
Same time, we strategically walked away from unprofitable sales by choosing not to reopen select gap and banana Republic stores as part of our ongoing fleet restructure.
Hi, I'm impressed with how quickly the teams moved across every aspect of our business, we launched new digital capabilities and shipping scale safely. We opened nearly the entire fleet of North American stores, and we pivoted to relevant marketing led by our values and chasing into product our customers want now.
So we entered the back half in great shape and understanding it will be unpredictable still with the opportunities to grow sales improved margin and invest in the business.
Well the back half comes back to school, which looks different from many families. This school year. What happened changed is the family ritual of shopping for supplies and cool cool close to allow kids to feel their best whether they're learning at home or socially systems in the classroom.
Since our brands to store to casual active and relevant we have the assortment, but as needed and any learnings scenario, we expect back to school season to extend over a longer period at some are ready to deliver for our customers online or safely in stores whenever they're ready to shop.
In a rapidly changing environment, we are playing to our strength focusing on the key advantages, where we can differentiate and compete to win now and in the future.
I'd like to talk for a minute now about our purpose driven lifestyle brands the backbone of how we meet customers' needs and ultimately create value for investors.
And the connections our customers have to our brand is strong and something we plan to amplify.
First old Navy, representing more than 50% of sales Oh baby is democratizing style offering customers trend right fashion in the values fade and growing market share in core categories like active in fleet lounge, and kids and baby as customers are turned to stores traffic in the brand off mall.
Let's see locations, which make up approximately 75% of the fleet wraps more quickly than other formats and continues to be advantage.
They dominated an online and customers respond to strongly to the marketing strategy to pivot to focus on brand values through the we are we TV spot and greater investment in digital channels to drive traffic.
Next gap, Yeah maintains strong emotional connection to its customers with its legacy a bridging the gap between individuals generations and cultures.
Second largest brands there is demand for this brand and we are committed to growing relevance and further reach two partnerships licensing and a greater focus on online gap brand is maximizing online demand through fresh energetic marketing and a decrease in discounting and the customer is responding.
Let us our fastest growing brand.
Clearly established as a lifestyle brand and a growing athleisure market.
And is extended gets reach to women and girls through female empowerment.
New experiences and storytelling that meet customers, where they are sort of focus on digital marketing investments the team unlock significant momentum in new customer acquisition during the quarter.
And banana Republic 'cause it has the potential to take share in a rapidly evolving marketplace by delivering accessible luxury.
Well it disadvantaged in the short term due to the shift toward casual fashion as people are working from home. The team is adjusting assortments quickly and pivoting storytelling with elevated product photography to drive online improvements.
Longer term, we believe banana Republic has a place to redefine work workwear for work leisure and oppose Kobin work environment.
Together, our brands are well positioned across age gender occasion, and life stage and each brand must deliver products and services that contribute meaningfully to our customers' lives through the strength customer relationship.
And the cornerstone of how we will extend and monetize our brands.
Another way, we differentiate it through direct customer relationship.
We have 60 million known active customers and a total customer file a 170 million, which we use to connect with our customers every day to increase our ability to tailor experiences content and product to a personalized.
We're excited to extend our loyalty program in September a capability that will enhance and builds over time and one that is key to deepening our customer relationship and fighting more loyalist to fall in love with our brand.
We're also expanding our reach to address market share opportunities like old Navys recent tween launch with pop sugar and the extension of GAAP team with a new collection for boys in Q2.
And we're excited about GAAP rents upcoming easy assortment, which is another example of leveraging our brand power to reach new customer segments.
Next our expansive online business an omni capabilities.
Our unique scale across all digital platforms and in our stores gives us advantage to deliver seamless experiences to our customers no matter, where they choose to engage in shop, and we will blow bolster this with the addition of two payment options pay Palin after pace, which we will launch this fall.
Positioning our brands to be digitally led and we're seeing that play out in our results even as stores reopened.
In fact during the quarter, we're proud to say that we added 3.5 million new online customers.
And in the midst of strong online growth our stores matter, serving as an extension of our E commerce experience and key the building customer relationships and community.
At the end of Q2, we have activated curbside pickup and buy online pick up in store across 1500, plus old Navy Athleta Banana Republic stores and add to this week gap brand is now live with this capability.
We know the value of our multichannel customers.
About 1.8 million multichannel customers in Q2, 30% of them had only shopped with us in one channel prior to this.
We can grow in each of these channels by differentiating our experience at the intersection of both and we are focused on growing our customer and online talent in order to do this.
Crucial to our success is relevant product.
With an average customer review of 4.5 out of five stars are style quality and fit are resonating with customers, which allow us to have greater pricing authority, resulting in less discounting.
The capitalization of American style, particularly in light of Cobot 19 has played to our strength fueling our active and fleece and kids and baby business, which represent nearly 3 billion and nearly 4 billion last year respectively.
Going forward, we see room to grow share in these categories, even after the pandemic.
And we can't talk about product without talking about masks and our commitment to encouraging health and safety.
We sold about $130 million and map in Q2 throughout through compelling consumer marketing and digital storytelling that has us ranked as the number one Google search results for face masks style guide as well as an aggressive b to B business launch.
The work the team has done to starting up this business, creating brand right designs that our customers lub continually improving them and scaling the business because the Ultimate example of how we want to operate at the culture chasing big audacious idea with speed and clarity all with the customer at the heart of our decision.
Which brings me to our lean operations.
Our our advantage across supply chain sourcing fulfillment real estate and technology enable us to unlock economies of scale. Unlike others. It has this scales that allows us to reopen are nearly our entire fleet of north American stores with a safe retailing playbook.
Which is helping to find the gold standard in our industry.
You can get leaner and Katrina mentioned, we're making progress and optimizing our cost structure, particularly as it relates to our store fleet.
And lastly, leading with our values.
The past few months of high highlighted the importance of companies with authentic values as consumers have become more in tune with how their personal values aligned with brands that they love.
We've always tried to be a company where everyone is welcome leaving on issues like gender representation and pay quality and our brands are positioned to stand out in front on these issues.
We are fostering a culture, where every employee has a strong appetite to win and to learn and I see the team raising the bar here I couldn't be happier with what I've seen. It is this that will allow us to build a larger platform a larger business from which we can probably share our values.
So as we look to be fashion gap inc. for the future leveraging the power of our brands and leaning on these key differentiators, that's what's going to fuel our success.
This is taking the seed in March the management team and I have been crystallizing, our long term strategic view of the company and we look forward to sharing our plans for value creation with gap for gap Inc. going forward at our virtual Investor meeting on October 22nd.
So with that I think we will open it up for today.
Thank you, ladies and gentlemen, if he'd like to ask a question. Please press star followed by the number one on your telephone keypad.
You're calling from a speaker phone. Please make sure you only function is also say you're seeing locally shacklett not also as a reminder, please limit your questions to one per participant.
First question comes from the line of Lorraine Hutchinson from Bank of America. Your line is open.
Thanks, Good afternoon.
The follow up on your comments on fulfillment cost and just see if you could parse out a little more detail on how you're thinking about fits in the back half where you think the fulfillment costs will go and then anything you've heard from some of your key carriers around peak holiday surcharges. Thank you.
Hi, Lorraine Katrina, so thanks for asking that question.
You know we had a very unique dynamic in our second quarter around fulfillment cost which was.
And when we send the inventory from stores, which is actually a good thing given the fact that our stores, we're ramping up and we were looking to ensure we were clearing that inventory and also servicing demand. It does result in some inefficiencies like split shipments and more expensive processing, so not weighed on the off.
The margin that we got in our second quarter as we think about the back half of the year certainly we expect that we will continue to have higher shipping because we expect our online business to continue to grow year over year, but because we've been able to now learn from second quarter and.
Better invest our inventories back into our online DC, we expect that a lot of the inefficiencies from shipping from store will go away and that it will be that part of it will be more normalized.
Now, let me just add a little bit about the the carriers then I will say is our teams have built.
LTE year long standing deep partnerships with the top carriers and and we stand.
With among the biggest of their customers we understand the dynamic is shifting certainly in the industry, but we believe we have a position of strength due to our scale, our differentiated scale and a multi year relationship where we help our carriers also develop new capabilities that they may be interested in doing and vice versa. So we believe it's a synergistic partners.
Ship that will play well for us and the scale is an advantage for us.
Thank you.
And our next question comes from Paul away from Citi. Your line is open.
Hey, guys bullish.
Could you talk about the progression of the old Navy results during the quarter and you mentioned off mall locations performing strongly at old Navy curious if you saw the same sort of dynamic in the other concepts calm and also just curious on store they didnt reopen Ah.
The cash.
Cost to get out of those leases. Thanks.
Hi, Paul So how does it relate to old Navy.
Think about the performance in the second quarter, but dynamic is very similar to the dynamic. We just described on our first quarter call, which is well leave you really performed the best is seeing the traffic rebound, but given the nature.
No. We and then you know as you can imagine banana Republic really performed worse and not a combination of their locations, but mostly the fact that you know weird, we're working through a pivot in their assortment to be more relevant in the kobin world where work needs to be redefine Sonya talked about.
Oh, sorry to say that continues to be the dynamic and gap in Atlanta sort of in the middle.
And then as it relates to the store closures, we haven't yet disgusted amount you know we're still to eat in negotiations on those and so that will be we were trying to be helpful. By providing the number of stores. We now have line of sight to closing both this year and that and then we will give you an update on on the full finance.
I will impact to that as well as the savings associated with that once we get more October of that yeah. I don't let me just add a little bit about old Navy you know with with net sales down 5% considering stores. The majority. The fleet was closed for in a range of 46 weeks, it's really impressive results and it shows the strength of the brand and the momentum that built.
As the quarter progress so I'll, just add that that a any of the dominant that'd be online business as reported a growing hundred 36% coupled with the pent up demand better store Saar customers really wanted to engage and we're ready to shop with us.
Based on mall locations based on strength of brand and product. So I think that the we want on both fronts and we're pleased with that it certainly the net promoter scores that we saw a in our stores as we reopened was a major advantage for us in our stores and you know maybe we saw double digit compared to last year.
Ah customer experience and so that was Ah you know I think some their customers really value the phase shopping environment. They valued the engagement you know the a experience that they had and I think shopping continues to be at very very important Mitchell.
Thank you good luck.
I'm not so though to Kimberly greenberger from Morgan Stanley. Your line is open.
Great. Thank you so much good afternoon, I understand that you under normal circumstances to provide I'm sort of the current tone of business understandable reasons were all just sort of operating in an environment that south so one certain so I'm I'm wondering if there is.
Perhaps either some month to month commentary in the second quarter or maybe in August any color on August or just what you're seeing during the third quarter that that could.
Help us what we try to put together the puzzle pieces of thinking about what the trajectory of the business looks like from here. Thank you so much.
Yeah, It's certainly the first half a volatile as you said and there was quite quite a bit going on and we still do expect you know a little bit of unpredictability. The short term, but we entered the back half in good shape and with momentum Yeah. We have strong financial liquidity to invest in the brand we have the opportunity to grow sales improved margin and embed.
In the business and we expect year over year sales performance to continue to improve versus the second quarter and you know the reasons why we believe this is a very unique strengths. We have our purpose led lifestyle brand and types of uncertainty brands matter and we're seeing that from our customers.
We have size and scale, which plays out on multiple fronts and our omni capabilities. So we believe we're advantaged to compete as we move into the second half.
And then Kimberly I think I'm going to at you know the cadence in the second quarter.
Isn't helpful and from a store standpoint, as you remember we were still reopening stores really starting in may into June and we weren't fully at 90% open until I guess late June July and our you know fully 90% open. So we have to the dynamic in stores opening Ah.
The good news is our online business I think you remember we said online was that 100% in May and we reported on line up 95% and so online while benefiting a little bit in made from some Ah shipping backlog really stayed strong as we opened our stores, which we believe it's a good fine how to customers respond.
Turning to our brands and products.
And then as it relates to some of the net sales performance I would say, there's nothing else really to report with June and July sort of about the same and so that's sort of how to quarter played out and then I think you heard in the prepared remark, how Sonia was describing back to school, but it really is very tight different time.
Downtick, where you know we're just we didnt see the peaks in Q2 that we normally see a memorial day and July four and people are just not shopping that way right now it's a very.
Smoothed out curve of how things are happening, but we still have confidence that people are shopping for those occasions, just shopping differently. Yeah. I mean, we believe the demand will be there at the back to school is that family ritual families by school supplies. They buy cool close to give kids confidence and whether there.
Looking at home or school, you know, we win a casual active and relevant product so having the assortment that's needed in any learnings scenario. If we feel confident in that and we've added to that we've got team got kids be the future it as well as old maybe pump sugar collections.
And look everything a change in this environment and you know things are definitely playing out differently around the world and that said we have the right to play in win in this space and when the customer somebody to shop and as we move further into the back half, we will be ready for that but the fashion needs that they have so.
Whether it's back to school, which could represent about 25% of our overall assortment, whether it's the broader back half yeah, I think that a the resiliency in the capabilities that we've honed in on give us that momentum and confidence as we move through.
Oh really great color. Thanks, ladies.
Next we'll go to keep Fitzsimmons from RBC capital markets. Your line is open.
Yes, hi, thanks, very much for taking my question I guess two quick ones here, what's interesting into slide deck. You guys noted that 10% of the revenues came from enclosed mall I believe you guys often speak about the 70% of the fleet is off mall I guess, just you know directionally.
With these closures relative to that 10%, where do you see enclosed small shaking out as a percent of sales you know in 2020 over time and then next just you know really quick you know on old Navy. Obviously 2020 is a whole new bag, but you know when we think about a return to a normalized call it needs.
EBITDA margin, how do you think about that will be a shift E com that you're seeing and no greater shipping expenses et cetera. Thank you.
Yeah, Kate all start first and foremost.
Oh, and just like you know that we're getting gives you a little bit more color on the breakout of what our and safely looks like as it relates to the type of mall.
Versus off mall, but I think it's fair to say that since the lions share of the closures were talking about are really gap brand and banana Republic that those will mostly be focused at the mall locations, but where that shakes out we'll provide that hopefully more insights you and the October call.
Yeah, Let me add some color about old Navy and E com and pressure you know it looked like we've been in the E com business for 20 years and that is good it's given us the ability over that's fine to build differentiated capability. We have a lot of automation, we have a lot of scale and in the value space, It's a big advantage for us.
As because were category killer and apparel, we have fine tuned in honed, our fulfillment and logistic supply chain to optimize and lower costs and to add up so yeah, we feel poised and differentiated there as we fuel this E com business in the values based you couple that with the strength of old Navys product March.
Jim.
And the advantage of the real estate format and cost of real estate and you know, we think that the economic model for old Navy, which we'll we'll share more in October as Katrina said gives us a lot of confidence.
Great. Thanks very much.
Next we'll go to Ike Boruchow <unk> from Wells Fargo. Your line is open.
Hey, everyone I'll answer the question, let me ask the question just two questions for me just I know you can we talk about margins in the back up sales are so volatile, but maybe between there just on the merchandise margin can you give us a little bit of quality and maybe what you all can they think it's reasonable to expect Q3 the backlog.
Hi, everyone loves it and then just maybe something that just bigger picture you guys on the portfolio brands, some underperformance and we're outperforming somewhat grade sort of thinking on how do you think about them all working together how do you think about you know the portfolio momentum on because of what you know what.
Probably got well, we got full solution.
Yes, I'd like to your first question you I Hope you caught in the speech that we were actually quite pleased said in the second quarter, we were able to realized improved product margins year over year as a result of lower discounting, particularly at old Navy.
I bought a gap and we attribute that to the fact that we had the right product as well as great inventory management and the teams are doing a nice job managing promotions in the face a stronger consumer demand for products.
So the way we had on our gross margins are merchandise margins in the quarter really were attributable to those pretty heavy fulfillment cost again, driven by a combination of the dynamic of having to ship much of that demand from our stores combined with increased online demand and so.
So as we think about the back half a year I would say, oh, well see where the product margins and up but we've been quite prudent and the way we think about our inventory purchases as you know get kind of inventory substantially when we went to crisis first hit and we've been very purposeful about what.
Categories were chasing into and what brand for chasing into in order to fuel that demand and that combined with the fact that we do you think you know where it nothing in marketing behind our.
Really relevant purpose driven brands, we have lots of.
Oh confidence that we can continue to see healthy margins in the back half and then the dynamic on shipping I think I described earlier, which is certainly won't be elevated fulfillment costs associated with running more online business, but we do aspire to have more moderated a impact from having to ship from our stores.
Yeah, Let me just add onto your second question you know the management team and our board a highly engaged and attuned to investor considerations and looking at the portfolio in considering all opportunities for value creation, what I will say is that what's different about us today is that we are a leaner faster more.
Focus gap inc. than prior and I've never felt stronger than I do now in this moment that these four brands have the right to grow and that we expect to see tremendous potential within the portfolio. That's what we're focused on and we're focused on unlocking that value through strong execution not.
Nothing it so I feel great about the management team these kind of management team and the commitment to this and we look forward to sharing more with you in October.
Hi, good.
And our next question comes from Janet Kloppenburg from J.J.K. Research Associates. Your line is at best.
Hi, everyone and congrats on the progress.
I'm very.
Interested in learning more about the gap that digital business, which is.
Seems to have taken off here why the stores continued to underperform, perhaps this will help us understand a bit more of that and all the transfer rates you expecting from the gap still closures in the malls.
And secondly, Sonia when you think about that digital opportunity and the investments you're making now how does that how does that square with the opportunity to expand the book and motivation of or maybe an outsider something that we've talked about as a growth opportunity probably thanks. So much.
Yeah listen I think gap has had a very solid quarter, you'll be online demand was strong as you noted as customers flocked to them because it's a trusted known brand and we saw improved execution across many many fronts as one of the highest store experience scores across the portfolio the E com business accelerated.
With with great execution, and the product resonated with some margin expansion product acceptance.
Really all fueled by the focus on brand clarity and brand positioning. So we're pleased with the momentum were seeing there I'd say is a your comments around stores you know what I would characterize is that we're walking away from unproductive sales a in gap brand and the stores that were intending to keeping the fleet we are expecting.
Continued progress on and we're seeing that through customer feedback and through the a conversion in our stores and raising the bar on ourselves in service to the customer. So Ah you know I'd say gap, we are taking to a leaner and more effective well on brand proud positioning and then.
You start to see some of that shape in Q2.
And then Jana I I guess, all just sort of add to your broader question. You go strategically we still feel like Oh, well positioned profitable store isn't advantage, especially as it relates to growing online business, because we know that customers are shopping online, but they're also uses.
Hey, par historically as an opportunity to come in it pick up or transaction a different way. So we still see there be quite a virtuous relationship between stores online and then the two brands that are looking to keep growing their store fleet, our old Navy and athletic and they're being very purposeful in that rose.
Maybe continues to believe that they are under penetrated compared to their competitive that in the smaller markets, where there are their competitors are but they are not and some will be prudent about watching that was coded, but we still think there's an opportunity to gain share there and that would let us still.
I had only 50 ish percent brand awareness and Underpenetrated in their store fleet still has an opportunity to open some doors here and potentially you know elsewhere. So more to come on that but we don't see that the two are necessarily conflict. In fact, we believe there's quite a synergy there is no two channel yeah, I mean that our scale.
So you know the omni capability, the omni synergy winning in our E commerce or in our stores through digital leadership is really where we think the sweet spot is.
Great and lots of luck.
Thanks Janet.
Next we'll go to mop Mark Altschwager from Baird. Your line is open.
Hi, Good afternoon. This is that fair Goldberg on for Mark. Thank you for taking my question I wanted to ask on inventory flows how repositioned for fall in terms of the flow of fresh receipts and do expect inventory to be a constraint I feel good about the ability to chip. Thanks.
Did you say I missed what you're going to slow.
You know inventory inventory fine okay.
Got it.
So I think we feel good you know, we just reported that without the pack and hold inventory were down about 10% in our ending inventory and we as you know as I think I said earlier, we had caught a lot of inventory for the crisis hit which in a way gave us the opportunity to really see how the customer shopping.
Okay, and in what channel and in which brands, which product categories. So we see that there's an opportunity to have used are responsive lovers and our speed capability to really get back into.
The brands that are performing well, particularly old dating Atlanta as well as to influence the categories that are working such as lease an active where kids and baby et cetera. So I think all of that said, we've been able to really position ourselves and then you've heard US say and then also in our online channel. So we've used.
The opportunity really leverage our capabilities to get the inventory hopefully where we believe the customer we shop, yeah and I'll just add that work every day, we are getting faster and expecting greater speed and more adds more agility. Some of the example, the come to mind for me in Q2, or the fact that you are with old Navy growing occupancy.
By 24% when we wouldn't be a taken such a conservative play on inventory at the acute moment in a in in the early part of Kobin shows the speed with which we were able to chase that demand right to deliver that kind of results are essentially chasing into the public a custom.
I just wanted and that's why does well you know to grow 7% in a quarter required us to really fuel that with the right inventory and the last example, my favorite one is talking about masks I mean, we were able to go from zero to 130 million due to the.
Stand up of a five weeks supply chain and these are just a tangible examples of where we're shifting in the speed that we're expecting a in order to be more and more responsive to a customer demand.
Great. Thank you for all the color.
Next we'll go to Matthew boss from JP Morgan Your line is open.
Great. So hopefully that's one of those corridor.
So two questions on gross margin on the sweet human proof gone is that's less negative than the second quarter or is forecast to watch gross margin expansions broker here. It's a rich you I'm going to Trina on as you know.
Look into the model with each of the brands is the goal as we should think about it took line cost savings that will flow to the bottom line or is it more to find opportunities to fund go forward investments, which we think about the magnitude of such Centralist piano.
Yeah, so as it relates to third quarter gross margin, we're not guiding that specific dynamic hopefully the commentary today. It's been helpful to you to understand that we'll see where sales plan on but fundamentally we believe the product margins as we saw that second core.
There are benefiting from strong product and strong brands and so we'll see how we compete in the back half and similarly, we've talked about the fact that you know we do still have some headwinds on fulfillment costs and again, we'll see where that land off so we haven't really been not specific.
And as it relates to actually I mean, we did do some pretty big moves in the first quarter. If you remember because about 15% of our corporate overhead and you know we've been focused on getting cost out of the system, but we were also trying to be helpful. In our acknowledgement of the fact that frankly.
Okay, and then coven environment, one of our bigger priorities is providing our customers would take place to shop and that does come with higher operating expenses in the stores off the good news is as you've seen you know customers are coming back far stores.
They are providing us with good net promoter scores associated with feeling faith in our stores. So we feel that's important.
And then if I said you know we are going to invest in marketing, we do feel like in this dislocated time in retail it's an important time for us to tell the story is are up for big brands that are competing well with the customers and so again, we'll see where that all plays out and if you know.
Oh, that's how we're thinking about the back half.
Great that's walk.
Next we'll go to Oliver Chen from Cowen Your line is hoping.
Joe now as well as I think you Multicarrier posh and could you just provide more color on the new customer acquisition you saw strong growth during the quarter, maybe which brand you saw the high new customer acquisition via online and how are you planning to drive repeat purchases from this customer. Thank you very much.
Yeah I do we're we're really thrilled about the customer growth, 155% growth and new online customers acquisition year over year and of course, because it'll be besides the distortion with an old maybe but we saw customer growth across the board a in E commerce and so.
Again, you know vis vis the advantage we have with this massive customer file that's growing in a differential way in E. Commerce, you couple that with values centered brand management and owning the these brands that have greater purpose and connect to customers in a time of.
Of complexity, you know I think it's a very uncertain time, our brands are connecting even more greatly and we're telling stories with a greater focus on that connection it's that combination at the intersection that we're finding that we can differentiate.
Next we'll go to Susan Anderson from B. Riley FBR your line.
Hi, cool so much for taking my call form.
I was wondering if you may be could expand a little but just on your thoughts on back to school. It sounds like you just like you expect that's even put the prolonged which makes sense, but I guess you think that you know there's been some wap wells or you know that yet really just some of it seems in Kabul. It.
Toward more of a weather events like the schools <unk> I guess more crop hold me.
[noise], Yeah, you know, what we're not going with typical peaks in the cobot environment over the course of the last many months if people are shopping over a longer period of time and so we expect back to school to be smoothed out over the coming weeks and months versus an acute moment in August like in prior years.
Yeah, we saw very similar behavior like this around memorial day, and fourth of July shopping that being said customers are still shopping for those of central products, whether it was summer product back then and so we've had experience now managing through these peaks and it's showing up in a different pattern, we're prepared to service that.
Need where whenever the customer is ready to shop, and we believe the demand will still be there, but back to school as I said is that family ritual and families want to buy their kids a relevant clothing to get them confidence you know, whether they're learning at home or school and we will win and we as we do with casual active and cool.
Assortments and so we've gotten some of this needed and we're ready to serve our customer as she engages with us and back to school.
Thanks.
So much.
Next we'll go to gain a tells me from Telsey Advisory Group. Your line is open.
Good afternoon, everyone I can see deposits in old Navy that you've made and I know something you've always talked about category opportunities there where do you see the old Navy opportunities coming from and do you see it is a margin in pricing any you are opportunity also and then on yes, let a business anyway.
Changes in how you think seeing that assortment and merchandise margin opportunities there Tim Thank you.
Yeah, I mean, let me is in way out first start by saying I know, we characterize a characterize 95% of R gap inc. assortment to be relevant to how customers are dressing today, we have always led the way with casual and comfort and you know often optimism which was.
People, which is what people are looking for right now and they're in their assortment. So that feels overall very good specific to old Navy and I thought I, what I will say is the active or an act active lifestyle dominance that they both have had been a massive differentiator at old Navy grew its occupants lease business by 24% in Q.
Two versus last year, it's now well north of a 1 billion dollar business I think your represented roughly a 300 million dollar business alone in Q2, and Atlanta also a yield a very dominant a across that across the gamut of their categories. As they really played to that lifestyles that active or not.
Is your lifestyle, so that that is the category space it but again really the underlying that underlying the premise is comfort and casual and we believe that applies to all of our brands is certainly GAAP random one with knits and hoodies and other product types because of casual and comfort as to.
Banana Republic with their niche products as well it's up some of their more you know a work leisure as we're calling it oriented products. So at least mover point is we have authority here. We always have it's really how we have built our business over decades is leading with the capitalization American style and.
So via this next wave is active and work we're riding that wave.
Got it.
Do you see margin opportunities to each of those businesses as a result.
Yeah, I think that we were pleased with the product expand price margin expansion in Q2, and we will continue to compete for that as we move into the back half.
Thank you.
Our next we'll go to Alexander Wallets from Goldman Sachs. Your line is out there.
Good evening, thanks, so much and taking the question I couple of questions from me before in what do you can share anymore color on traffic trends, perhaps you know sharing any color on discrepancies between the difference between different geographies.
Well my how about all shapes up so it seems like conversion in muscle.
Yeah. So as it relates to traffic I think you know when we said earlier is that similar to the dynamic we described last quarter Oh, all babies locations are benefiting from the better trends.
And you know banana is suffering the most that said the other dynamic we're seeing is that traffic is sort of hard to look at and those people who come in our highly qualified buyers and so we are seeing stronger sales over traffic trends for people who come in you know really with the purpose to.
By but again traffic is it a little different because a lot of the traffic and starting online there's curbside pickup interest in different omni channel dynamic, but fundamentally you know on it on a scale I would say old maybe is a definite banana just based on its product category right now is.
Though the weaker up the brand and what I will say as we pivoted to purpose led a Brad Brad marketing and you saw some examples of that in Q2, whether it was that we are we advertising from old Navy or the beat a future advertising from gap, Brad or the athletic advertising celebrating you know people on.
Power amid a as we had zone did on that on purpose driven marketing, we've seen that positively impact traffic and slow or into both channels.
Okay. Thank you Sandy I think yeah that that sooner call and absolutely will be available for any further questions and nickel everyone's hazy unhealthy.
[noise] Kinky that does conclude our call for today. Thank you for your participation you may now disconnect.
Oh I'm sorry.
[noise] mhm.
Mhm.
HM.