Q1 2023 Gap Inc Earnings Call
Speaker 1: We are improving near-term execution and requiring a much deeper and integrated focus on the customer to unleash each brand's potential.
Speaker 1: Also simplifying our operating structure and model, reducing costs, improving speed of decision making and unlocking our creative muscle.
Speaker 1: and modernizing our core capabilities that have been on Gap Inc.'s roadmap for far too long.
Speaker 1: I understand that we have surfaced these issues before and what I would say is simply this work has been derailed for far too long and it is imperative that we get after it in earnest.
Speaker 1: The need for change is permeating the organization and I am very pleased that our teams are embracing the work and behaviors needed to get us there.
Speaker 1: The leadership team is committed to getting the work done and have put structure, process, and leadership accountability in place to ensure that we do.
Speaker 1: Now, let me give you a little more specific insight to the actions that we have been taking.
Speaker 1: First, we took immediate action to improve our near-term execution and brand performance.
Speaker 1: We have moved quickly and effectively at clearing excess inventory, improving assortment, particularly in old Navy and GAP, resulting in share gains in both women's and baby in Q1.
Speaker 1: The company delivered over 600 basis points of adjusted operating margin expansion compared to last year, driven by significantly improved gross margin from the reduction of excess of air freight expense and improved promotional activity as well as adjusted SG&A leverage.
Speaker 1: And our balance sheet is stronger.
Speaker 1: We ended the first quarter with nearly 40% more cash than last year.
Speaker 1: Almost 30% less inventory than last year, and we paid off 100M of our outstanding ABL balance just last week. While also continuing to deliver an attractive quarterly dividend to our shareholders.
Speaker 1: Now let me speak to each of our brands.
Speaker 1: Starting with Oak Navy, comparable sales were down 1%.
Speaker 1: Old Navy's momentum continued into the first quarter with market share gains.
Speaker 1: driven by strength in women's as well as a reversal of trend in the baby business that was offset by softness in active and kids.
Speaker 1: The Old Navy team, under I.O. Barbato's leadership, remained focused on stabilizing the Corps and elevating execution which contributed to improved margins, resulting from its leaner inventory position and balanced assortments.
Speaker 1: Styles with a clear fashion point of view and diversified end use like woven tops and pants performed well giving customers the option to go from casual to dressed up thanks to outfitting cues focused on versatility.
Speaker 1: The team also continues to lean into its responsive capabilities in order to place inventory buys more efficiently and remain flexible to chase into demand or pivot if the customer needs shift.
Speaker 1: On GAPRAN, comparable sales were up 1% driven by continued strength in women's, a modest improvement in baby, and offset by weakness in kids and active.
Speaker 1: Gap Brant's focus on amplifying its icons is truly resonating, as the team focuses on reintroducing the most modern versions of its iconic styles.
Speaker 1: This shows up as updating styles like our women's silver pole leather jean and on-trend take on our classic cheeky straight denim offering.
Speaker 1: And I'm encouraged by product improvement in other categories as well, including denim, woven tops, and dresses which showed up with increased versatility.
Speaker 1: The team uses responsive levers to chase into best-selling women's denim like the baby boot and high-rise stride as well as trending woven tops, fur gear driving growth in these categories.
Speaker 1: Moving to Banana Republic, comparable sales were down 8% on top of an outsized positive 27% comp last year.
Speaker 1: While still early on its journey, Banana Republic continues to make progress establishing itself as a premium lifestyle brand and is resonating with our customers.
Speaker 1: This March it unveiled the our home with a curated collection of rugs, bedding, decor, and more. All capitalizing on the BR customer's appreciation for great style, design, and quality, and leveraging the deep home lifestyle talent.
Speaker 1: and expertise of the Banana Republic leadership team. We look forward to more expanded collection in the future.
Speaker 1: And finally, Atlanta.
Speaker 1: which posted comparable sales of negative 13%, which were below planned for the quarter.
Speaker 1: As we discussed last quarter, athletics near-term performance was negatively impacted by continued product acceptance challenges, including color, print, and pattern misses.
Speaker 1: And from strain too far from its performance DNA.
Speaker 1: Delivering the best product for our customers is the highest priority and while the team is focused on making improvements in the assortment, we know it will take time for those changes to fully take hold.
Speaker 1: While we continue our search for a new leader for Athleta, we are leveraging the great talent currently at the brand.
Speaker 1: including our new Chief Creative Officer Julia Leach, as well as some of our best merchandising and product talent from across our portfolio of brands.
Speaker 1: Collectively, they are leaning in and making improvements where we can, including better presentation of the product that is working and elevating our marketing and creative expression.
Speaker 1: and across Gap Inc. We are still watching the channel shifts closely.
Speaker 1: While online sales were down single digits in Q1, they are up close to 40% from pre-pandemic levels in Q1 of 2019.
Speaker 1: As the consumer continues to shift back to stores, we remain focused on delivering the optimal omni experience for our customers across all brands and all channels.
Speaker 1: Second, we've made significant change to our organizational structure and are actively improving our operating model to unlock a period of muscle, heighten accountability, and empower talent by removing bureaucracy, complexity, and outdated processes while also reducing cost.
Speaker 1: These changes are pivotal in restoring our strengths and priority around design, innovation, style, and trend.
Speaker 1: We flattened the organization by reducing layers from 12 to 8 and increasing the average span of control from 2 people to 4, still with the intent of getting to 5 or better informed by best-in-class benchmarks. All of this to address execution, inefficiency, and improve decision-making quality.
Speaker 1: performance over the long term and again most importantly in creative and product execution.
Speaker 1: Fundamental shifts included combining merchandising inventory management under one leader to oversee the end-to-end process fueled by consumer insights.
Speaker 1: bringing channels together under the commerce and experience lead to drive omni thinking in the end-to-end consumer experience and splitting marketing leadership into two roles one focused on creative and brand identity and one focused on execution and analytics
Speaker 1: And we have also centralized G&A functions that were previously embedded in the brands to create efficiencies and better leverage the scale and expertise of our portfolio.
Speaker 1: These changes result in eliminating approximately 1,800 positions and when combined with our earlier actions last fall, reflect approximately 25% of our headquarter rolls, a significant contributor to nearly 550 million in estimated annualized savings on a cumulative basis.
Speaker 1: I know we all can understand these decisions are always very, very difficult to make, especially when saying goodbye to team members that we care about.
Speaker 1: Beyond these organizational changes, the bigger payback will come when we show up as a more informed, faster, and more creative company, delivering brand and cultural relevance to our customers.
Speaker 1: We have organized not just to improve the cost structure of this company, but with an eye toward best-in-class industry standards and setting ourselves up to deliver long-term results.
Speaker 1: To be clear, this is not a one and done cost cutting exercise.
Speaker 1: We are after a mindset and cultural shift that will be part of our evolution as we go forward.
Speaker 1: The teams are now in place and in consistent pursuit of efficiency. We will continue to look at additional opportunities to rationalize our technology and marketing investments and exploring ways to further optimize our cost structure longer term.
Speaker 1: More to come as the team gets in deeper into this work.
Speaker 1: Thirdly, we are modernizing our capabilities to build a healthier company at the core and ultimately change the trajectory of our business.
Speaker 1: Through these improved capabilities, we are focused on key product and market functions, including re-establishing core merchandising processes and pricing architectures.
Speaker 1: amplifying and leveraging customer insights and analytics, and leading in further to our vendor partners in our product development processes as we further elevate our responsive capabilities.
Speaker 1: Lastly, to bring leadership, structure, and accountability to ensure we drive this work to completion, we have put a transformation office in place under the GAP, Inc. leadership team. And we've engaged external consulting partners to even further drive rigor.
Speaker 1: processes and day-to-day disciplines to support the team through this period of significant change.
Speaker 1: We have also aligned a significant portion of our incentive compensation this year to the achievement and completion of our cost transformation efforts.
Speaker 1: Our leaders and our teams are committed to this change and I'm proud of the progress today.
Speaker 1: And finally, before I turn the call to Katrina, I want to address our CEO search and the comments made by our Lead Independent Director Mayo Shattuck in our earnings press release today.
Speaker 1: When I took the role of interim CEO in July , I did not expect to still be speaking to you on our first quarter earnings call. But this only underscores how strongly the board is committed to appointing the right person as our next CEO , one who has passion.
Speaker 1: strong vision and customer obsession that will take this company forward.
Speaker 1: We're deeply engaged toward the appointment and look forward to the time we will introduce you to the new CEO of GAPI.
Speaker 1: Let me move us on, but I hope this provided a bit more clarity around our commitment to shoring up the foundation of this company for the long term by lowering our cost structure, building a culture of creativity and empowerment, and reorienting our business toward the customer.
Speaker 1: These types of foundational changes paved the way for future CEO to take over a business that is healthier, more productive, and ready to compete and win. And with that, Katrina, I'll pass it over to you.
Speaker 2: Thank you, Bobbi, and thanks everyone for joining us this afternoon.
Speaker 2: The actions we are taking to significantly reduce excess inventory, improve category and assortment balance, transform and optimize our operating structure, and significantly reduce operating expenses, while further fortifying our balance sheet, have allowed us to enter fiscal 2023 better positions.
Speaker 2: During the first quarter, we delivered net sales in line with our expectations driven by continued women's category strengths at Gap and Old Navy, despite the weaker sales at Athleta. Over 600 basis points of adjusted operating margin expansion as we drove down excessive air freight expense.
Speaker 2: and delivered significantly improved promotional activity, most notably at Old Navy, and leveraged adjusted SG&A.
Speaker 2: Reduced inventory down over 27% year over year, which was only up 3% versus first quarter 2019.
Speaker 2: and ended the quarter with cash and equivalents up 38% from last year to nearly $1.2 billion.
Speaker 2: While we believe we are making progress to better position our model to deliver for the long term, we continue to take a prudent approach in planning and managing our business in light of what continues to be an uncertain macro and consumer environment. We remain focused on the levers and opportunities in our control to deliver on behalf of our customers, employees, and shareholders.
Speaker 2: Let me start now with our first quarter results. First quarter net sales of $3.3 billion decreased 6% versus last year and were consistent with our expectations for first quarter sales to be down mid-single digits.
Speaker 2: As a reminder, the sale of GAAP China at the beginning of the first quarter had a two-point negative impact to net sales growth and there was also a one-point foreign exchange headwind.
Speaker 2: Excluding GAP time of sales of approximately $60 million from Q1 last year and the foreign exchange headwind, total company net sales would have been down 3 percent. Comparable sales were down 3 percent in the first quarter. Door sales decreased 4 percent from the prior year.
Speaker 2: Online sales decreased 9% versus last year, and we're up 39% compared to pre-pandemic levels in 2019.
Speaker 2: Online represented 37% of total sales in the first quarter.
Speaker 2: Turning to sales by brand, starting with Old Navy, sales in the first quarter of $1.8 billion were down 1% from last year. Compared to 2019, Old Navy sales were up 2% in the quarter.
Speaker 2: Although we believe Old Navy continues to experience demand softness from its lower-income consumers, we're pleased to deliver first-quarter comparable sales down 1%, which was a continued improvement from fiscal 2022, driven by strength in women's and a modest improvement in Navy, offset by continued softness in active and kids. Old Navy continued to gain share in the quarter, driven largely by market share gains in the last quarter.
Speaker 2: and the one point negative impact due to the shutdown of Yeezy Gap, sales were down 1% versus last year, largely driven by store closures in North America.
Speaker 2: Gap-red comparable sales were up 1%, driven by continued strength in women's, a modest improvement in baby, offset by continued weakness in active and kids.
Speaker 2: Gap brand continue to gain market share in women's as it reinvented icons are resonating with consumers.
Speaker 2: The Nanora Public sales were $432 million in the first quarter, with comparable sales down 8% on top of a positive 27% comp last year. While the transformation of BR into an elevated lifestyle brand continues to take hold and resonate, the brand is lapping outsize growth last year driven by post-COVID shift in consumer preferences.
Speaker 2: which is impacting year over year growth.
Speaker 2: Athleta sales of $321 million were down 11% from the prior year, or an increase of 45% compared to 2019 pre-pandemic levels.
Speaker 2: Comparable sales were down 13%. As we told you last quarter, Athleta has had product acceptance challenges, which we believe are impacting results.
Speaker 2: While we know it will take at least a few quarters to make meaningful changes to the assortments, the team has been at work to improve product presentation and creative with an emphasis on the performance DNA that Athleta is known for.
Speaker 2: Now to gross margin in the first quarter.
Speaker 2: Reported gross margin was 37.1%. Adjusted gross margin increased 570 basis points to 37.2%.
Speaker 2: Merchandise margin on an adjusted basis increased 610 basis points.
Speaker 2: This was driven by approximately 560 basis points of leverage as we lapped last year's elevated air freight and drove our normalized air expense down.
Speaker 2: Approximately 330 basis points of B leverage due to inflationary cost headwinds as we are now selling products locked in at last year's peak cotton prices.
Speaker 2: This was slightly better than the 360 basis point headwind we anticipated, as we are beginning to benefit from better ocean rates.
Speaker 2: and the remaining 380 basis points of leverage stemming primarily from improved promotional activity relative to last year, primarily at Old Navy.
Speaker 2: Rod, as a percentage of sales, deleveraged 40 basis points versus last year.
Speaker 2: Now, let me turn to SG&A. Reported SG&A in the quarter was $1.2 billion, including a $47 million gain related to the sale of our 1 Harrison office building, offset by $71 million in restructuring charges related to actions to optimize our operating structure.
Speaker 2: including the reduction of approximately 1,800 corporate and upper field roles. As we discussed last quarter, the actions we are taking to optimize our operating model and structure are expected to result in an annualized savings of $300 million, of which half we estimate to benefit SG&A in the second half of fiscal 2023.
Speaker 2: advertising expense and lower technology investments resulting from our cost saving actions late last year.
Speaker 2: Reported operating income was a loss of ten million dollars.
Speaker 2: Adjusted operating income, which excludes restructuring charges and the gain on sale was 18 million dollars in the first quarter.
Speaker 2: Adjusted operating margin improved 620 basis points from last year to 0.5 percent in the quarter, driven by the 570 basis point improvement in adjusted gross margin and 60 basis points of adjusted SG&A leverage.
Speaker 2: Reported EPS was a loss of 5 cents.
Speaker 2: Adjusted EPS, which excludes restructuring charges and the gain on sale, was one cent.
Speaker 2: Adjusted EPS, which excludes restructuring charges and the gain on sale, was one cent. Share count ended at 368 million.
Speaker 2: Turning to balance sheet and cash flow, starting with inventory. Ending inventory has declined 27% in the first quarter versus last year. This includes a 17 percentage point benefit related to in transit as we lapped the prior year's supply chain challenges.
Speaker 2: and four percentage points of decline related to pack and hold inventory. The remaining decline is primarily driven by a decrease in fashion and seasonal basic inventory. As you know, we made significant progress right sizing inventories as we exited fiscal 2022.
Speaker 2: We remain focused in fiscal 2023 on moderating buys, leaning further into our responsive levers and continuing to integrate the inventory that was placed in pack and hold in fiscal 2022 into future assortments.
Speaker 2: As a result, we are planning for inventory to be down significantly more than sales as compared to fiscal 2022.
Speaker 2: Quarter-end cash and equivalents were nearly $1.2 billion, an increase of 38% from the prior year. Net cash from operating activities was $15 million in the quarter, driven primarily by improved inventory levels and leaner buys.
Speaker 2: Capital expenditures were $117 million.
Speaker 2: Consistent with typical first quarter seasonality, free cash flow was an outflow in the quarter of approximately $102 million.
Speaker 2: We remain confident that cash flow trends will continue to normalize throughout fiscal 2023.
Speaker 2: As we told you last quarter, we expect to be positioned to pay down the $350 million draw on our asset backed line of credit this year. In fact, last week we paid down $100 million and intend to pay down the remaining $250 million balance throughout the remainder of the year.
Speaker 2: We remain committed to delivering an attractive quarterly dividend as a core component of total shareholder returns.
Speaker 2: During the quarter, we paid a dividend of 15 cents per share, and on May 9th, our board approved maintaining that 15-cent dividend for the second quarter, fiscal 2023.
Speaker 2: Now turning to our outlook, we continue to take a prudent approach to planning in light of the continued uncertain consumer and macro environment.
Speaker 2: Starting with Q2, let me first provide an overview of factors impacting year-over-year sales comparisons in the second quarter.
Speaker 2: Gap China represented approximately $60 million in sales last year in Q2 and is expected to be an approximate 1-2 percentage point headwind to gapping for the quarter.
Speaker 2: We are assuming an estimated 1 point foreign exchange headwind in the second quarter.
Speaker 2: We are estimating total net sales in the second quarter to be down mid to high single digits year over year, reflecting a range of outcomes based on what continues to be an uncertain macro and consumer environment.
Speaker 2: We expect gross margin improvement in the second quarter versus last year. Compared to the 36% adjusted gross margin in the second quarter last year, we anticipate an estimated 200 basis points of leverage as we lap last year's elevated air freight and continue to drive lower normalized air expense.
Speaker 2: an estimated 200 basis points of deleverage due to inflationary cost headwinds, primarily cotton costs headwinds similar to Q1.
Speaker 2: We expect these inflationary headwinds to moderate and become a tailwind in the back half of the year as we benefit from lower commodity prices as well as improved ocean freight rates.
Speaker 2: This 200 basis point inflationary headwind is expected to be fully offset by improved promotional activity as a result of improved inventory positions relative to last year.
Speaker 2: And Ron is expected to de-lever by approximately 50 base points compared to last year.
Speaker 2: We are planning for adjusted SG&A of approximately $1.3 billion in the second quarter, largely reflecting the continued benefit of last year's savings actions offset by higher incentive compensation. Thank you. Thank you,
Speaker 2: As discussed previously, we expect to begin to benefit in the back half of the year from $300 million in annualized savings related to the actions we are taking to optimize our operating model and structure that we began implementing last month.
Speaker 2: Now, turning to full year 2023, as a reminder on the factors impacting year-over-year comparisons,
Speaker 2: Gap China represented approximately $300 million in net sales last year, representing an approximate two point headwind to gapping in fiscal 2023.
Speaker 2: Fiscal 2023 will have a 53rd week, estimated to add approximately $150 million to net sales for approximately one point of growth.
Speaker 2: As we look to the remainder of fiscal 2023, we continue to believe net sales could be down in the low to mid single digit range for the year.
Speaker 2: Turning to gross margin, compared to the 35% adjusted gross margin in fiscal 2022, adjusted gross margin in fiscal 2023 is expected to be driven by an estimated 200 basis points of air freight leverage as we lap last year's elevated air freight and continue to drive down normalized air expense. Approximately 50 basis points of deleverage versus last year stemming from inflationary costs.
Speaker 2: basic points of leverage in the back hat as we benefit from improved commodity costs and ocean freight rates.
Speaker 2: We continue to expect more than 100 basis points of margin benefit in fiscal 2023 as a result of our better inventory position and expected improved promotional activity compared to last year.
Speaker 2: And ROD as a percentage of sales is planned to be roughly flat to down approximately 50 basis points compared to last year. We continue to target fiscal 2023 adjusted STNA to be down low to mid single digits from the prior year or approximately $5.2 billion. As we communicated last quarter, the higher incentive compensation and wage inflation plan for fiscal 2023 was not
Speaker 2: 1800 corporate and upper field roles.
Speaker 2: We now expect capital expenditures in the range of $500 million to $525 million, down from our prior range of $500 million to $550 million, largely reflecting lower capital project investments as well as fewer store openings than previously planned.
Speaker 2: We now plan to open a net 25 to 30 Old Navy and athletic stores in total, roughly one third Old Navy stores and two thirds athletic stores. We continue to plan to close a net total of 50 to 55 Gap and Banana Republic stores in North America of which approximately more than half are Gap stores and the remaining Banana Republic stores.
Speaker 2: We are entering fiscal 2023 better positioned as a result of the actions we are taking to change the trajectory of our business, not only in the near term, but even more importantly, setting the company up for the long term. We are confident in the actions we're taking and believe we are taking the right steps to position Gap Inc. back on its path towards sustainable, profitable growth and delivering value for our shareholders over the long term.
Speaker 2: With that, we'll open up the line for questions. Operator? Thank you. As a reminder, 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 question and answer queue.
Speaker 2: Our first question comes from the line of Alex Stratton from Morgan Stanley . Your line is open. Great. Thanks so much for taking my question. I have a couple that are probably best answered by Katrina, so both related to revenue. So on the quarter, is there any color you guys can give us on how it trended? Was it consistent? Did it strengthen or weaken?
Speaker 2: Hi Alex, thanks for the question. So I think on your first question I would say we are obviously pleased that we were able to deliver on our expectations in the first quarter for revenue and what we observed I think is largely in line with what we've heard others report which is that February was quite strong and probably benefited from the fact that it was warm everywhere.
Speaker 2: And then in March, we definitely saw similar weakening to what I think you've heard articulated largely as a result of the regional bank situation that was playing out and the impact that that had to consumers as they tightened in March. And then a little bit of a recovery in moderation in April .
Speaker 2: But, you know, we're navigating the lower tax returns. So again, delivered the quarter, but what we're observing is a much choppier environment for the way that the consumer is reacting to the news and how that's impacting the way they spend. As it relates to Q2, then...
Speaker 2: We have seen a little bit of that softness continue into May, but what I would say is that that's considered in the outlook we just provided. And the reason why we gave a range for Q2 is that, you know, we're trying to provide for whatever scenarios could potentially play out with some of the choppiness that we're seeing out there. And if there are.
Speaker 2: situations where the consumer contracts. So hopefully that's helpful, but that's how we're thinking about it. Super helpful. Good luck. Thank you. Your next question comes from the line of Matthew Bause from JP Morgan. Your line is open.
Speaker 2: So hopefully that's helpful, but that's how we're thinking about it. Super helpful. Good luck. Thank you. Your next question comes from the line of Matthew Baus from JP Morgan. Your line is open. Great, thanks.
Speaker 3: So, Bob, you cited market share gains at the old Navy brand. Maybe could you just expand on trends that you're seeing in that business and how you feel regarding the balance today in your assortment, maybe relative to what you see driving the softer athletic performance? Yeah, hi, Matthew. Yeah, I mean, we're certainly pleased to see the market share gains at the old Navy brand.
Speaker 1: As I think you were sort of referencing, it's really where our mind is as well. We still see the brand over assorted from where we want it to be. And again, that's just part of this transition that we're working through. But we've continued to see good gains in and around.
Speaker 1: categories that we believe that we'll continue to see greater strength in. The brand itself is in a period right now again of making a lot of those adjustments coming out of cleaning up its inventory, getting rid of the pack and hold and so forth. I think the kind of performance that we'll see going forward will add a little bit more clarity around the categories in particular that In my view, we'll see so far the number of attacks that will take effect in a year. However, we do see a dip rise over the next couple of months or so, in the period at which we think we'll have participants have even added a tiny turnout during those social planning 75 Dawn –
Speaker 1: we believe the brand will really thrive on long term. But right now I'm happy with the progress and again, to see the kind of gains help us with some momentum. Look, on Athleta, it's just really clear that we walked away a little bit too far from our performance DNA.
Speaker 1: definitely had some misses in and around product specifics, silhouettes, color, and even just some of the styling, etc. And that really, again, gave us a big challenge relative to that customer, what she's coming in for. Although our bottoms continue to be really strong, we have to be able to capitalize on a lot more than that.
Speaker 1: And everything that that brand stands for, for that customer, you know, we're not backing down from it all. The power of she, the emotion in the brand, performance, why we, you know, are moving aggressively to get in more aggressively and like running, yoga, some of those areas that we know have been real big misses for us. Is what that team right now is really focused on and as we
Speaker 1: We're optimistic that we're gonna get back where we need to be. We're gonna get back where we need to be.
Speaker 4: Your next question comes from the line of Brooke Roach from Goldman Sachs. Your line is open.
Speaker 5: Good afternoon. Thank you for taking our question. Can you talk to the composition of your inventory today and your current ability to chase into products that are resonating with the consumer? How much chaseability do you have and do you think that could potentially improve your performance into the back half of the year? And then similarly, Katrina, can you provide some updated comments on your outlook for free cash flow?
Speaker 2: levels. And I think you saw that show up in the gross margin performance for the quarter where you know we were able to still offer a lot of value to the consumer but we didn't have all the markdown cleanup from last year that we had to deal with and so we were able to really clean up the overall margin. So we feel good about that piece as it relates to Chase I think.
Speaker 2: We've talked about this. We're now back to being able to reinstate our responsive capabilities and a lot of the organizational structural changes that we made in the business will also help us really have better line of sight to end to end inventory management and allows us to get back to really casing end to.
Speaker 2: trends that are working. I think what's different is that Old Navy is back to pre-pandemic levels of chase, if not slightly better, but now we have the capabilities across our brands, which is really nice to see. And so all of our brands should be able to be chasing inventory much closer to the consumer. I don't know if you wanted to add anything, Bobby? No, I think you covered it. Well, I think, Brooke, the one thing that I would just highlight again from my seat is
Speaker 1: with innovation and, you know, all of that that moves through the pipeline. So, to your question about our expectations around the back half, I would say the answer is yeah. I mean, we believe that we're finding ourselves back where we've got great leverage points. We're seeing good success as we chase back into product. And again, really getting back to that discipline and rigor in a very effective way. So.
Speaker 2: I'm actually proud of that progress, really, quite proud. And then, Brooke, as you asked, obviously our discipline around inventory and expenses combined with better operating performance is giving us more confidence in our free cash flow outlook. I think you heard on the call the free cash flow was down 102 million in the quarter, which is...
Speaker 2: very in line with our seasonality and back to a much more normalized level. In fact, that's a lower level of outflow than we normally see in Q1 based on the fact that we have such tight inventory and expenses. And certainly our aspiration is to get back to generating free cash flow in the company through better operating performance. So more to come as we see where the year comes out.
Speaker 4: Thank you very much. I'll pass it on. Your next question comes from the line of Lorraine Hutchinson from Bank of America Global Research. Your line is open. Thank you. Good afternoon. I'm curious to hear more about the reduction in promotions at Old Navy. Can you talk about where margins are versus pre-COVID levels for that brand?
Speaker 2: inventory has really allowed us to clean up the markdown piece of the business, which doesn't add a lot of customer value, right? That's just inventory that last year wasn't responded to well by the consumer and we had to sell through, given excess inventory, the wrong inventory. So the margin benefits coming from cleaning up that markdown.
Speaker 2: increases. The team was very surgical around taking up prices on categories or items that are known to be important in the consumers wardrobe right now like wovens or pants or are outstanding fashion items that just you know are so well that the customer has to have it.
Speaker 2: I would say as we look back we feel very good about where the teams have priced up and the promotions have remained rather competitive as far as versus pre-pandemic. We're still better off than pre-pandemic.
Speaker 2: Thank you. Your next question comes from the line of Jonna Kim from Cowan & Company. Your line is open. Hi, this is Neil Goh filling in for Jonna today. Thanks for taking my question. Just kind of touching on this from your point earlier, can you just give some more color on the slide?
Speaker 6: how that promotional environment has been perhaps different income cohorts and demographics since that was one of the brighter spots. And then what are you assuming from a timing perspective for the rest of the year as we eventually enter the back to school period.
Speaker 2: Thanks. Yeah, Neil, so I think what's interesting on our income cohorts is that it continues to be similar to what we've seen in the back half into Q1, which is when you look at markets where we have a demographic of a low-income consumer. We are certainly seeing those...
Speaker 2: consumers contract their spending and being much more price sensitive. In areas where we have the higher income consumer, there's a lot less price sensitivity and they are still spending. So that dynamic has continued and as of now, we'll see how that plays forward.
Speaker 2: But that's part of the reason why we have ranges of outcomes around our revenue performance is because we don't know what will happen as we head into the back half of the year and decide whether we will need to compete more or less. I think so far what we've seen, and maybe you've heard this more in the industry, is that
as we just talked about, we've had to do less promotion to clear inventory because our inventories are so much more in line. And really, our promotions have been more focused on adding value to the consumer, which we hope will be more revenue-driving actions and less about clearing inventory. So there you have it, SMU futur tot $ Hey! Smu any
talked about, we've had to do less promotion to clear inventory because our inventories are so much more in line and really our promotions have been more focused on adding value to the consumer which we hope will be more revenue driving actions and less about you know clearing inventory. Great, thank you.
Your next question comes from the line of Corey Tarlow from Jefferies. Your line is open. Hi. Good afternoon. First, I'm wondering, Katrina, if you could just assess for us the health of the Gap Store fleet. I think over the last two years you've closed something like 370 stores.
the segment actually comped positively this past quarter. So it would be helpful to just get some color there. And then just on the Old Navy improvement that you're witnessing, recognizing that there's still more work to do, maybe could you talk a little bit about what that work is and how far along or maybe what inning you think we're in in terms of the Old Navy improvement.
Yeah, Cori, as you say, historically, we've worked aggressively on over the last three years during the COVID pandemic. So as you say, overall, we have closed.
or will have closed by the end of this year, about 350 Gap and Banana stores. So both of our specialty fleets we've been working on. And do I think we're done? I don't know, but we are largely through the lion's share of the restructuring activity that had to be done. And I think if you say that is showing up in the fact that.
As it relates to Old Navy, I think you've heard us call out that we feel really good about the fact that we gained share in women. I think we would say that we would like to keep seeing more momentum in men and kids. And then within, you know, some of the categories, I think active is an example whereRequired, when people have more momentum in their government.
We've gained a lot of share over a multi-year period, but we're seeing a little bit of reversion there and there's probably some more work to do to get that assortment back to being current. But I don't know, Bobby, if you want to comment more on the old Navy. No, I mean, again, I think we're kind of indicating again we're seeing it travel along the journey here and getting the assortment really rationalized and balanced the right way. You guys realize this? Correct.
as well as we do, this across all brands. But I mean, we design into the coolness to the brand relevance, the creative, being right on fashion and getting inventory under control. Always when we do that, we're always gonna do a better job in driving brand relevance.
maximizing marketing effectiveness. That certainly is true around the right promotional approach and balance for O'Mavy. And in turn, I think continue to allow it to produce the kind of margin that we want to see it structured to run with and compete with and get back again to really the essence of that brand. That brand's always been known for.
for fun if you will, and you know the brand itself is, or the team is working around what future of fun looks like around that brand and how it differentiates itself in the marketplace. Staying close to the customer, you guys touched on it, and I'll just acknowledge it back. You know, that's a value proposition that we know we compete in very aggressively.
I like the work that the team is doing, the rigor they're putting in around the right diagnostics at every level. Whether it's online or in-store, this merchandising structure change, we're moving ahead of commerce, so we're bringing together both the online and the in-store together.
around the experience and everything we're doing from a product and service is all a part of these improvements that you know again we're counting on and Old Navy in particular probably one of the bigger beneficiaries as we as we land all that work.
Great. Thank you very much and best of luck. Your next question comes from the line of Mark Altswager from Baird. Your line is open. Good afternoon. Thank you for taking my question. I wanted to follow up on the promo topic as well and gross margin.
It seems like the promo recapture was really the key driver to the upside expectations in Q1, at least relative to our model and I think how many were looking at Q1 gross margin. Is that magnitude of recapture a good run rate to think about as we move to the next few quarters? And given your comment about promo shifting more to in
being used to engage the customers versus clearing inventory, if we were to see some moderation in that Q1 result, I mean, would it be fair to think that we could maybe see some incremental top-line benefit as we move through the year? Thank you. Yeah, Mark, it's such a good question and one I'm really glad you asked. So, the upside in Q1, as you say, we saw modest upside from freight, which we talked about, but really
moderation. And then for the full year we said at least 100 basis points in that discount. And you know you could ask why wouldn't we see more? I think right now what we're saying is that's the the way we'd say maybe a floor of what we think that's worth. We'll see how hard we have to play.
in Q2 and beyond depending on where the consumer goes and whether that shows up in revenue or whether that shows up just in us having to play harder to be able to compete as we move through the year. So I'm glad you asked the question. Those do moderate as we get through the year. And once again, go check it out at our website, ww. dying
you know, depending on where the customer lands, we'll see whether there's upside there or not. Very helpful. Thank you.
Your next question comes from the line of Paul Kearney from Barclays. Your line is open. Hi, everybody. Thanks for taking my question. Can you talk more about some of the efforts to reduce costs and simplify? How will the changes you've made improve responsiveness throughout the organization, and are there additional levers to drive sustainable savings as you rebase this year? Thanks.
Hey, folks, Bobby. I'll start and see if Katrina wants to add on to it. But look, I think it almost goes without saying, you know, getting rid of layers from 12 to eight, the effect on span of control, it's really clear that you know, where we found ourselves was really slowing down and
impacting our ability to be quick on decision making, as well as certainly identifying where we've had productivity misses and the like. So that work, I don't think should be understated. It's difficult work that's gone on, but we found ourselves with an SG&A, obviously that was untenable, not one that we would.
look to continue to try and compete with. So, you know, pulling out the cost is relevant and it's meaningful, but again, I just go back and point to the big payback and unlock here is again, as I've made in my comments, I mentioned in my comments, you know, the big payback is when we're gonna start showing up more informed, more in tune with the customer being driven by consumer insights, more responsive and the like. So, take some time to learn today on this journey. I'd love for you to know how to make the all-in on this story in just a few seconds. So thank you to HostDA for loosening up the opponents and just for being here today. Otherwise I'd love to break up the? and get started quick, with this description from spreads of the product. So yeah, thank you on this journey for obsessing
We're not doing anything here other than I hope what you caught is we're in pursuit of a mindset change and a cultural shift that keeps us in this mode all the time of continuous improvement and looking at how we continue to not just cut the cost, but again, get ourselves where we're far more responsible or responsive, agile, and again, a lot more competitive.
I have just one more time, I'd say difficult work in the short time that I have been here, although that filled all that short. I'm really pleased with again, the way the team is embraced this change. Any of us that have watched this level of change happen, we know it takes a lot. And right now, I think our quarter results indicate some good, or show some good indication of where we have reason to be pleased with part of it. But we have a lot farther.
areas that we've identified we have further opportunity in and now that we have our organizational structures in place and those teams get settled we'll begin the work to really understand what the next opportunity will look like. Somewhere to come when we get through the organizational change and are able to sort of move our focus to those next items.
Congratulations on the improvement. Nice to see. Katrina, on the promotion, and Les, we capture that assumption for the second quarter. Is that a trend that you're seeing right now, and do you feel even with your inventory down as much as they are that...
you've had to step up promotions. And I also wondered in your guidance for the second quarter and for the year, what the assumption is on kids and men? Do you expect those categories to improve or do you expect that pressure to be maintained as we move through the year?
And lastly, I wondered if there was any news on denim and how that might be affecting your back to school outlook. Thank you so – oh, and one last question, Tori, is just on where we should expect inventories to trend going forward. Sorry, thanks. Thanks, everyone, for joining us on developing this week's show.
No worries. So on the gross margin and promotional trend, I mean I'm not really going to comment. It's very early in the quarter, so we'll see. We've given you a sense for the year, I mean for the quarter and the year where we think those things will land. And so you know we'll see how it goes. You know Memorial Day is coming up. That's usually you know big kickoff.
There's sort of a range of possible outcomes for both kids and men as we look to the second quarter and the second half, all of which are contemplated in the guidance we gave.
And then on the denim front, you know, we've been gaining share in denim all year and we gained share again in Q1. So we're relatively pleased with what the teams have been doing around denim and I guess, you know, we'll see how that plays out in back to school, but at least we've got some good momentum heading into basket back to school in that category.
There was a fourth one, I can't remember. That was it. Okay. Inventory, Katrina, inventory. Oh, inventories. Yeah, so we said in my, or I said in my speech that we do expect for inventories to be down meaningfully more than the sales guide. So, you know, we'll see, but we did end up down 27 and that'll be our goal is to.
to keep those inventories well under control. Thank you and good luck. Thank you. Ladies and gentlemen, as a reminder, please limit your questions to one per participant. Your last question will come from Marnie Shapiro from the Retail Tracker. Your line is open. Hey guys, congratulations on some really nice improvements in the...
and for winter gifting? And then we can also just think forward. Do you need new leadership in place to start innovating?
Even this is a part of the market that is heavy on innovation, the performance part of the market. And while I like a lot of the styles you have, some of them have become a little stale while other brands are advancing in this moment. So I'm just curious if you could talk about those two parts of the business. Give me a star. First of all, thanks for being so kind.
I think enabled a lot of moves and changes there. We've already seen wonderful contributions from Julia Leach, who we added is kind of fresh perspective on the creative side. You do understand obviously quite well because of the question that fabrications and other things really are a little bit longer pipe for this brand. That said.
you know, the brands taking every opportunity we can, where if it was an opportunity for raw material to be adjusted a bit, to land something for fall, perhaps holiday, there are opportunities being engineered into that. But to go much farther than that,
I think that's a bit too aggressive. At the same time, this seems amazing me right now, everything that they're doing to come up to maximize opportunity. What's most important obviously here is, again, we know what this brand stands for, we know what she looks for every time she comes in, you just highlighted it again. It'll take us a while to get back where we need to be, but hopefully we will exceed your expectations and mine.
I hope so. Can I just ask one follow-up? You've been promotional, obviously, to clear out the inventory, and it's going to take some time to fix this. Even within the store today, are there things that she's buying that don't need a promotion, and is there a risk that she gets used to 20% off, 30% off, 40% off there? How careful do you have to be over the next couple of months in dealing with this?
But there is a reality of sort of where we are today and where we need to go. The ultimate goal will be to get that brand back to not relying on promotions to be able to drive the business, but drive the business through its fashion authority and its innovation and its positioning. And that is what the team is working towards.
long term. So it's a great question and one that the team is definitely focused on. Tell the team I'll welcome back the new product. Enjoy. Best of luck for the next quarter. Thanks, Marty.
Thank you. That does conclude our conference call. You may now disconnect.