Q2 2019 Earnings Call
Thank you.
That's your new ladies and gentlemen, my name is Cody and I'll be a conference up later today.
At this time I'd like to welcome everyone take Yapping second quarter 2019 conference call. At this time, all participants are any listen only mode.
For those analysts who wish to participate in a question and answer session. After the presentation.
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I would now like to introduce your host.
Money.
Senior director of Investor Relations.
Good afternoon, everyone.
Gapping second quarter 2019 earnings conference call.
Before we begin I'd like to remind you that the information made available.
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For information on factors that can cause or actual results to differ materially from the forward looking statements.
As well as the description in reconciliation of non G.A.P. financial measure as noted on page two of the slide supplement remark.
Please refer to today's earnings.
As well as our most recent annual report on Form 10-K .
And our subsequent filings with L.P.C.
All of which are.
Gapping Dot com.
Yeah.
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Information as of August 22nd 2019.
And we assume no obligation to probably update or by our forward looking statement.
Joining me on the call today, our president and C.E.O. Art pack and executive Vice President N.C.S. military list all.
As mentioned, if we really using sites to supplement a remark, which you can view by going to the investor section of <unk>.
With that I'd like to turn the call over to our.
Good afternoon, and thank you for joining us today I'll start with an overview of the quarter at the enterprise level.
And then walking through our performance by Brad.
They're Terry will take you to the financial.
Or separation activities remain on track and we're making excellent progress.
Will provide more details at our September 12th.
The management of that.
Turning to our results profit, we made a challenge which contributed to overall demand falling below expectations.
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We have more work to do to position ourselves for consistent delivery in this challenging retail environment.
Well, we have a clear action plan in place and are seeing sequential improvement in the areas that will drive improve results.
Better product quality acceptance increase responsiveness marketing effectiveness.
Prove productivity and an optimized store fleet.
We'll talk about these.
Through the brand results and even more at our meet the management event in September .
Let me spend a moment inventory productivity, which is a key element in improving our go forward results.
In the quarter, we were disciplined and managing inventory and I'm pleased that each of our brands ended the quarter largely clean from a liability and maturity perspective.
We've adjusted back half inventory buys to better match, the traffic trends that were saying adjusting Q3 as much as possible and even more aggressively adjusting to four.
As it stands today, we have planned or back half inventory to be down.
We will use our responsive capabilities to chase into units as the quarters actualize in demand materialize.
Increased focus on operating discipline improved execution and measured investment in marketing and tell it across all brands is driving slow.
But positive momentum that gives me confidence as we head into the important back to school and holiday seasons.
Well I'm optimistic about the progress we'll see in the back half our results and performance across the industry.
Demonstrate the need for continued discipline around S.G.N.A.
Reducing human Tory commitments.
Increasing store conversion and improving marketing effectiveness.
But that in mind, let me take you through how we're thinking about our current performance in positioning beginning with old Navy.
Just to start and to remind you.
Old Navy is an exceptional business with exceptional economics.
It's a big box family value category killer.
With excellent for while economics, and a discipline cost structure.
It's grown sales in Com were the last three fiscal years, and we see a lot of white space for continued store expansion you'll hear about September .
We know the fundamental economic model works.
And we had had some significant misses on execution.
Let me remind you of where we've been so you can better understand our outlook for the second half of the year.
As we move to the queue for last year softness in women's became more broad based.
T quickly began to diagnose the drivers of the issue.
And determined the product offerings to narrow she wanted more choice and more new to us.
Because his diagnosis came over holiday, we were limited in our ability to meaningfully impact first two quarters of the year or product design and merchandising perspective.
And this is reflected in our results.
The teams began a redesign of Q3, incorporating the key learnings the extent they could.
And since work on two four had not yet begun.
A holiday assortment the commercial in marketing plans.
All built from the ground up with the benefit of key learnings from Q4 2018.
In addition, as we saw slowing traffic trends at the start of this fiscal year, we work to cut units out a few too.
And brought immaturity leader to reflect trends.
Coming back to Q2, while I'm, obviously not pleased with our performance we did come into the quarter, knowing it would be challenging.
We knew the product wasn't quite where it needed to be and we react quickly.
During the quarter the teams appropriately focused weary through summer product and ending the quirk clean.
In order to better positioned the redesign fall product for the important back to school season. As we look ahead to Q3, we are still facing some challenging traffic trends.
Teams are hyper focused on this.
And when we hit a bump in the road in the past would product issues.
If it's been predictable latency in terms of traffic catching up.
Understanding this dynamic relieving with our strengths in the back half from a product perspective, specifically leaning into denim.
Where we are pleased with the results active which is performing and fleas, which we believe we have a lot of upside in.
All of which had positive comps in Q2.
Amplifying or category strengths with focused powerful marketing to dry brand relevance buzz.
And we're also implementing traffic driving initiatives to bring her back into the store.
Most recently, we remerchandised inside the store in terms of product placement.
50 old Navy locations and while we did this very recently received very early but positive results that we will intend to roll across the old Navy fleet as we read the test results.
Well the first half has been challenging there's a lot to be proud of and even more we're excited about the future.
Our views on the fundamental strike for the business and the power of the old Navy brand remain unchanged.
Well Davies market share position hold strong at 3.1%.
It remains the number two largest apparel brand and the number nine largest retailer according to M.P.D.
Before I moved from Old Navy I also want to talk about a talent shift recently made as the brand moves toward operating as a standalone public company.
Last month, we announced that Nancy Green was served as brand present it out let us for the last six years would join old baby.
This is Nancy third time at old Navy and unites the product and marketing functions under a single leader.
This will provide significant support to the old Navy CEO don't you're single its remit expands to leadership over a public company.
Not yet named a replacement for Nancy It athletic.
But this is quite honestly a coveted role in interest has been tremendous.
In the meantime, we have a strong aligned senior leadership team guiding the brand.
And I am providing additional support to that team until we're ready to name a new leader.
Now, let's turn the gap Rand.
Traffic remains challenging and it's the biggest challenge at the brand, but it's also important to note as we previously called out.
That we intentionally shifted marketing dollars to very late in Q2 and into Q3.
Corresponding with gap brands, new denim lunch and back to school.
Despite the traffic challenges, we did see all channels at the brand deliver positive sales over traffic for the quarter, indicating improvement in the customer response to product.
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We've made meaningful improvements to the product engineer round.
With tighter strategic priorities process improvements and talent and structure changes.
Women's bottoms is a bellwether category when to turn around starts it's around the bottoms customer.
That's why they have been so focused on accelerating data while the products has only been in stores for a few weeks.
Early returns are very encouraging.
As we look ahead to the back half of the year, we have a better assortment.
Increase marketing investments fomenting build them in that.
A top to bottom ratio that isn't the right balance and inventories in better shape.
Leaner and with liable down 25%.
In terms of product marketing and gap ran or focus for the ball is clear.
Kids and baby for back to school and at them.
There are clear areas, where we can and will win and where we're ready to reassert the authority of the brand.
Over the past few weeks you may have seen our marketing campaigns in both of these areas and will continue to turn up the volume in this space.
Our specialty store fleet rationalization efforts at gap Rand are also on track.
We'll provide more detailed here in September .
And we're also experimenting with some promising new store formats at the brand as well as low investment improvements that make a major difference in the experience of our customers.
For those of you in New York at least consider visiting our flat iron location at 17 and theft.
See how minor changes can make a big difference when you put great products. This case denim front and center.
For those of you outside of New York I would encourage you to stop by Garden State Plaza and see how this concept executes in a traditional mall environments.
Gap as large and complex business.
And when we say gap Rand.
We're really referring to an assortment of components, including especially business an outlet business.
Online channels and an international footprints.
That N., let me highlight an area marketable progress gap outlet.
We bought that part of the brand under new leadership, a little over a year ago.
And now we've seen five consecutive quarters of positive ESO tea and four quarters of positive gross margin over traffic.
Trend is improving.
Finally, while the calm sales a gap ran this quarter one satisfactory.
This is a brand that remains powerful and relevant.
To give just a couple of examples while anecdotal our loyalty program has now launched across all gap round stores in in July surpassed 5 million numbers tend to spend 20% more than non numbers.
We also see strength and demand globally for gap logo product.
Based on units sold and fiscal 18, an interesting statistic is that we sell 1.3 gap ran logo products seconds 365, all around the world.
Let's move to the Nana Republic, acutely <unk> <unk> <unk>.
They deliver a positive June we'd inventory.
And settled in the new field organizational structure, which is gone through significant changes in the first quarter.
The first August slow hit stores.
The initial responses positive, though traffic remains down the brand.
As we've already discussed increasing traffic starts with improving product.
From a product perspective.
We've had a carry over a basic set banana that we referred to previously.
Just made it harder for doing it.
Fashion cut through in our stores.
What we're addressing that by working to grow capacity with our fastest vendors.
Have more depth and confidence in key products.
With a clear point of view and to cut through and stores with a flat or higher gross margin.
Raso innovating a banana.
To make it easier to shop and to attract younger customer.
By on line pick up in store will launch later in August in the R. and in September consumers will be able to take advantage of the rental subscription service were calling styled passport.
Finally to Atlanta.
I'm pleased with the acceleration of the athletic business from Q1, as we clear through the softer swimming categories.
And the momentum we see as we head into the second half of the year.
We've reinvested in marketing it the brand, which drove increased demand and healthy customer growth.
And we're on track to end the year with 185 athletics stores and we're accelerating store openings approximately 25, you stores this year.
As we look at the second half the team is cited about the launch of supersonic a new highly technical bare trade certified fabric made with recycled nylon from pre consumer waste designed specifically for high intensity activity.
This has helped reduce 15 tons of waste the date.
Which interestingly enough to wrap around the Earth 247 times.
More importantly, the early reads on consumer acceptance engagement with the various products with this fabric is in has been very positive.
Perhaps one of the most exciting developments RAF leather this quarter was the announcement of our first ever athletes sponsorship with Allyson Felix.
Allison is the most decorated female track and field athlete in the U.S. Olympic history.
Allison will support is an athlete and as a mother and an activist, whereas let it in competitions and in your daily life, and we'll continue to work with us to enhance the technical performance of all of our products.
I'm really excited about our partnership with Allison and all the new programs, we're launching across new Coke brands like inclusive sizing it athletic.
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As we move towards separation investments like these.
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Change as we become two independent companies.
There are commitments, we have made to our employees.
Your line into the Q2 2019 earnings release Conference just one moment.
I look forward to talking to you more about the planned separation.
We made in September .
And now I'll turn it over to Terry to take you through the detailed financials Terry.
Thanks Art and good afternoon, everyone.
As art indicated our results this quarter are not where we want them to be.
We talked about the tough start to may in our last call and despite sequential improvement in comp trends at all brands with the exception of Banana Republic, the tough start weighed on the quarter.
That said I am pleased that we have continued to make progress in two key areas operating discipline and productivity.
Let me use inventory as an example, again, while not fully where we want to be we made progress with ending inventories clean and second half planned receipts much leaner, we ended the quarter with inventory favorably positioned versus Q1.
In the productivity area, we continue to leverage the work initiated last year to inform the operating model design and spending targets of the two planned new companies, we're seeing meaningful cost savings in the current year, but more importantly, the productivity mindset is taking hold as a part of our culture.
Turning to second quarter performance as a reminder, our reported results include approximately $70 million in cost associated with our planned separation certain tax adjustments related to new guidance from the tax cuts and jobs Act of 2017 and costs related to our previously announced fleet restructuring.
We've excluded these costs in our adjusted results and comparisons to provide a better view of the base business.
So starting with sales net sales for the quarter were $4 billion down 2% to last year comp sales were down 4% compared with positive 2% last year.
Spread for the quarter was largely driven by new store openings at old Navy and Athleta as well as non com, gaining Jack sales, partially offset by gap store closures.
As our talk through while disappointed with the by brand comp performance in Q2 were more confident with the set of heading into the third quarter with the work. The teams have done to strengthen product, particularly in key categories. Like denim. In addition to the adjustments we've made to our inventory levels and in our commercial and marketing plan.
Moving to gross margin, our second quarter gross margins were down 90 basis points to 38.9%.
An improvement from our original expectations.
Old Navy continued to be the primary driver of de leverage in the quarter.
Merge margin was down 70 basis points, primarily driven by old Navy, partially offset by GAAP brands.
As I discussed the margin de leverage at old Navy was primarily driven by our efforts to clear the underperforming women's products and some reliable in order to end the quarter clean and to better position the improved fall products.
At gap brand. The team continues to focus on maximizing yield through improving product assortment and a leaner inventory composition.
Rent and occupancy Deleveraged 20 basis points, primarily driven by lower net sales.
Regarding us Jumei on a reported basis second quarter total operating expenses were $1.3 billion when excluding costs associated with our planned separation and fleet restructuring as June a as a percentage of net sales Deleveraged 40 basis points again, primarily driven by the lower sales.
Given the challenging business, we remained prudent debt expenses within our control, which helps drive the improvement from Q1 trends.
Moving to taxes and interest the effective tax rate was 38% for the second quarter.
Excluding the impact from adjustments to our fiscal 2017 tax liability related to tax reform guidance issued during the quarter as well as the non cash tax impacts related to restructuring charges. Our normalized tax rate was about 12 points lower.
We expect our full year reported effective tax rate to be about 30%.
Excluding the current quarter onetime adjustments to our fiscal year 2017 tax liability for tax reform guidance and certain noncash tax impacts related to expected restructuring charges. We continue to expect our full year adjusted effective tax rate to be about 26%.
Turning to earnings.
On a reported basis earnings per share were 44 cents.
Excluding costs associated with separation and specialty fleet restructuring our adjusted earnings per share were 63 cents.
FX was a detriment of about a penny for the quarter. So we do not expect FX to have a meaningful impact for the year.
On inventory, we ended the quarter with inventory up 6% compared to last year.
Consistent with Q1, there are a couple of drivers behind the increase including about a three point impact driven by an increase in in transit time.
About a two point impact from the Genie in Jack acquisition and about a one point impact from store openings net of closures.
On a normalized basis that means inventory was about flat to last year.
A significant improvement from normalized Q1 levels, which were up 5%.
While we have more work to do I am pleased with the progress in the engagement within the organization to improve inventory productivity. We have invested in many of the core capabilities that should eliminate the waste in our buying process, including responsive capabilities that allow us to reduce the risk in our buys and chase into styles that are working.
We're driving leaner initial buys and building stronger open divide processes that better leverage the responsive capabilities, we have built.
We expect inventory levels to continue to decrease in the back half to approximately negative low single digit.
While noting that in transit could cause fluctuations in this point in time metric on a reported basis.
Ultimately over time, we would target inventory growth at less than the rate of net sales.
We also will be working to improve allocations based on channel demand in localizing our assortment.
Improvements in each of these areas are expected to drive higher yields and gross margin return on investment as well as improve our working capital profile.
Turning to cash flow year to date free cash flow was $259 million, an increase of $39 million over last year.
We ended the quarter with $1.5 billion of cash cash equivalents and short term investments ahead of our historical target of $1 billion to $1.2 billion.
Year to date capital expenditures were $324 million.
As we mentioned last quarter, there are meaningful capital investments needed to facilitate the separation primarily in technology and logistics.
We continue to assess the expected capital needed to execute the separation and we'll provide updates as we move forward.
We continue to expect our fiscal 2019 capital expenditures to be about $675 million inclusive of 100 million of non routine expansion costs related to one of our headquarters building and the Buildout of our hydro distribution center.
And $575 million of base capital with priority is continuing to be focused on profitable growth opportunities at old Navy in Atlanta, and investing prudently in technology and supply chain initiatives that position each of the future companies for sustainable growth.
Additionally, we remain committed to returning cash to shareholders.
We completed an additional $50 million of share repurchases during the quarter and we continue to expect to repurchase approximately $50 million per quarter for the balance of the year.
Our philosophy has not changed and we remain committed to our dividend.
Year to date, we paid dividends of $183 million.
Regarding store count year today, we added 39 old Navy in athletic stores on a net basis and acquired 140 Genie in Jack location.
At gap brand, we closed 16 stores, primarily in North America net of opening primarily in Asia.
We ended the quarter with 3356 company operated stores.
We continue to expect 30 net store closures for the year.
With regard to our earnings outlook for the remainder of the year on a reported basis. We now expect earnings per share to be in the range of $1.88 to $2.08 for the full year.
For the full year, we now expect restructuring related costs to be about 14 cents versus our prior guidance of 29 cents.
This reduction in cost is primarily related the shift of certain lease buyouts from 2019 to 2020.
We remain on track to close about 230 specialty stores by 2020, and we continue to expect total cost of the program to be about $250 million to $300 million with the majority expected to be cash expenditures.
For the full year, we now expect costs associated with preparing for and executing the separation to be in the range of 20 to 30 cents I would caution that this is still a preliminary estimates and will provide additional information in context as we move forward.
Excluding the first quarter gain on building sale cost associated with preparing for and executing the separation restructuring costs and any related tax impacts as well as the second quarter tax reform adjustments. We continue to expect adjusted earnings per share to be in the range of $2.05.
$2.15.
Regarding gross margin, let me take a second to give you some color on the cadence on the back half of the year.
For the third quarter, we expect gross margin deleverage should be slightly better than our first half trends.
For the back half, we expect year over year leverage to be about flat as we lap the easier fourth quarter comparison from last year.
Regarding tariffs as others have mentioned, we continue to closely monitor the tariff discussions.
Our teams have contingency plans in place for the back half related to the list for terrorists, including partnering with our vendors to sharing the cost as well as pricing actions.
On pricing the teams are working on a targeted pricing strategy in certain categories, where we have pricing authority, which is a broad based increase in pricing.
CN mitigate the impacts of list for tariffs would be an incremental six cents impact to our guidance based on current estimates.
So through our mitigation and contingency plans, we would expect this impact to be much lower.
Let me close by reiterating our confidence and conviction in our plan to launch old Navy as a standalone public company.
We believe the best position both companies to compete effectively in this evolving retail landscape.
Our short term priorities remain unchanged and we expect that focus on operational discipline to deliver continued progress as we move through the year and with that we'll open it up for questions.
Thank you as a reminder, for those analysts who wish to participate in a question answer session.
The presentation you May press. These four key followed by the digit one to ensure that into the queue. Thank you.
Our first question will come from Mark Altschwager with Baird. Please go ahead.
Hi, good evening, Thanks for taking my question.
Looking at Old Navy I know you were planning a tough quarter, there, but can you give us a sense of what you're seeing behind the scenes, that's giving you the confidence that some of the process and the assortment fixes are in place and any lingering issues that would keep old Navy from Comping positively in the back half.
Yes. Thanks.
It's sort of detailed a bunch of things obviously that we've been working on for a while as well as moving Nancy in there as well.
And I think it's really a combination of all of the above as we look at really understanding and diagnosing where we had issues and again as we noted there primarily in places in the women's assortment.
And making those changes as we got into Q3 and Q4.
Well I didn't spend a lot of time on also on the call is or in my statement is that we're looking at and really digging exceedingly deep on our marketing effectiveness to make sure both that weve optimized the mix that we have the right amount of money going against marketing and that we're getting the pull out of the creative content. So this is a.
This is a no stones unturned.
Basically pushed against the business to make the business performed the way that we can perform so I'm not going to I'm not going to make a call here on what we expect to see in Q3, and Q4, but I have confidence in business as I stated upfront exceptional four wall model I know what the runway is in front of the business and as I noted again, there's some foundational categories, where we have continued to see strength denim being a critical one active and fleece being other ones as well and those are really important royalty categories, hi, guys I'm going to follow us any kind of guys will be leaning into as I had said in his comments.
While we expect to see progress in the product performance in fall.
Point out then is really holiday when we had the opportunity to really start from scratch.
More like sequential progress from falling into the holiday assortment and then the other piece is just you know Terry went into this and I mentioned it briefly is where are we on liability and we feel like we're in a very good spot from an inventory standpoint and.
When you are pushing a bow wave of liability and you're trying to fix a product problem simultaneously. It's tough we're not pushing in poway liability were in very good shape from a clean inventory standpoint.
That's great color. Thank you and maybe just a quick follow up on the other revenue really re accelerated this quarter I know theres a few things in that line and you mentioned some positive trends athletic, but any more detail you can share on the drivers there.
Yes, the biggest piece of that of course is that a lot and we are very pleased with the crowd, but as you as you recall it was the revenue recognition changes that's also where credit card.
Income is as well now and so there were some stronger trends there as well largely due to some timing issues. We don't expect a big changing and credit card for the year, but but definitely in the second quarter first half or more some more favorable trends playing trail, but but the bulk of it in Atlanta, and we feel very good about what we're seeing there.
Great. Thanks Best of luck this fall.
Okay.
Thank you we'll take our next question from Paul Lechem with Citi Research.
Hi, Thanks, guys can you share your assumptions, maybe where you expect by brand, but say the biggest improvement and the back half are you looking for positive comps.
For any brand by the time, we get to the fourth quarter and then just separately I'm just curious if you're right now we're dealing with a 10% tariff situation art. If we were faced with the 25% does that change your view on the split the company into two does that something it's better to tackle as a combined entity or do you just stay the course thanks.
Yes on the first one I don't we're not is not going to call out comp trends in the back half we've been.
I think we've been pretty clear that we want quality revenue.
And that we are focused on yield and an early indicator to me of getting strength back in the business will be and in places. We have seen this where were seeing a positive spread over our gross margin dollars comp versus our sales comp called that out in gap outlet.
And so.
I think in this environment you have to focus on quality revenue first and foremost that's rather than super tight and lean on inventory why we are keeping inventory open why we are reserving the right to use responsive capabilities, where we see that we can feed so fuel into the into the businesses and right now we're using that as we've seen some success and GAAP denim to put some additional units to support the denim business with the fall launch.
So it's really a quality revenue issue first and do I hope for positive comps, absolutely, but I want to see that on a foundation of quality revenue rather than we're out there getting a bunch of units through the system as low quality revenue. So that's number one.
On the tariffs were we are as Terry noted, we're steadfastly focused on executing I'm pleased with where we are on the technical work associated with.
Building the platform for the separation of the companies the business reason, which is what we've been calling out all along for doing so remains intact.
We're going to use all the way to this company to participate the conversation to protect the American consumer we do not think these tariffs are a constructive that they have a constructive impact on the consumer Terry noted that we're working to mitigate them rather than speculate about contingencies I'd just say, we're focused right now and obviously reading all aspects of the environment that we're operating in as we do the work to make sure that we're that we are confidently on the right course, and we are quite confident that we're on the right course now.
Thanks, Good luck.
Thank you we'll take our next question from Dana Telsey with Telsey Advisory group.
Good afternoon, everyone.
Going back to old Navy for a moment I think when the quarter started may started off sorry, what did you see as you went throughout the quarter and I saw the denim customization studio and flat iron. So definitely experience is becoming more part of it are we going to see anything like that in old Navy and with the down 5% comp that you had seen it improve as we go through basically from product or promotion how are you thinking about it. Thank you.
That was a lot of questions Dana.
So on the I'm glad you saw flat iron.
We are pretty excited about how that store showed up and obviously there are some elements in there that you are not going to see everywhere, which is why I call out Garden State Plaza, which is a pretty traditional mall. This store has a center thats been around for a long time.
Just to see our presentation shows up there what you will see executed in every one of our gap stores is a proud funds front and center denim moment, where we stand for denim and windows that support that and we feel like she is getting that and she's seeing the new fits that we have and she is reacting to it quite well.
On old Navy.
The positive comp is going to come back first and foremost because of project substance. We are tight on inventories, but we know we have room for the war yield standpoint, even with tight inventories plus bringing to bear our responsive capabilities to feed units into the business. So I don't want to calling in Mecca call.
So just to make sure that we're not missing something long way, where we need to be and then we're continuing to put marketing into support the business really across all of our businesses.
And then then answering your first question have lately seen within the quarter definitely saw sequential progress.
As you move from May one to weather inflected in and the product is more seasonally appropriate we definitely saw sequential progress from June and then into July .
And I would let me just comment on whether for a second because I just have my senior leadership team together yesterday as we were looking at the business and looking forward and the weather for the rest of August September October November December was right in the middle of the table, which and we've increasingly built this into how we think about our commercial plan, whether we should put the pedal down and move some product. If we are going to be looking at unseasonable weather.
Or whether we should keep our powder dry if we know that the weather is going to turn.
As we look at September we believe that the weather patterns should be favorable and should for most consumers around the country really pretty just pretty definitively signal a seasonal change into fall and that is something that has historically been been a good indicator for the business.
Thank you.
Thanks.
Our next question.
The boss with JP Morgan.
Great. Thanks, maybe Terry on the gross margin so a slight improvement in threeq relative to the 122 basis points of contraction in the front half implies roughly 100 basis points of expansion in the fourth quarter, how how would you rank the drivers of that inflection and just your level of confidence.
Oh, well, maybe slide you have to define better thats, what I want to point out that as you think about the comparison that going up again combined with the sequential progress we expect to see in the business.
There would be meaningful margin expansion in Q4.
Versus versus last year, just because you know when you look at the combination of those two factors, but a slight might be.
Bigger improvement in Q3 than than you are factoring in.
Okay, and then maybe art just a follow up in light of your comments regarding the challenging traffic trends heading into Threeq you just any early thoughts on back to school for either GAAP or old Navy and just your confidence as we are as we head into that important season.
Yeah, I know I've watched as I've seen those come out and give some pretty definitive statements about how they see the business based upon pretty short amount of selling and I think as I've mentioned in.
In previous calls that we've had is that year over year over year, we've really seen back to school become a less acute event and for that demand to spread out really from a July period into post labor day.
Depending upon climate school openings and those kinds of things. So we're frankly, we're focused on driving traffic and driving sales across that whole period.
Labor day is big for US, we think the weather trends are going to be attractive weve adjusted inventory trends to to match with where we think that the Q3 is going to come in.
So I'm I'm I'm focused on frankly, delivering the entire quarter to be honest and.
We'd rather not comment on what's really only a couple of weeks as the season started spool up.
Great Best of luck.
Well hear now from Kate Fitzsimmons with RBC capital markets.
Yes, hi, Thank you for taking my question.
No definitely appreciate the more conservative view on inventory units into the back half I'm just as we work to get old Navy back on track can you speak to chase capability at that brand that makes you think that you can access the units you might need in order to drive comp improvement or should we think with the back half as really more of exclusively in a you are recovery story, just where we broadly with lead times in that business and flexibility on the sourcing side and how are you feeling about the supplier base there or just any disruptions to note in light of the trade tensions. Thank you.
Yes, I'm I'm, it's a category specific capability, because if you're looking at.
Outerwear as an example.
That tends to be long lead times sweaters are long lead time, just because of the nature of the manufacturing process. If you look across.
Key categories and the business denim in particular, we have adequate capacity to put more than enough units into the business. If we saw that we were reading upside there now I can't put it in a week.
If I look at Q4 and reading trends in Q3, we have plenty of open and plenty of vendor capacity to put units in the business next would be the same thing to a certain extent certain types of woven tops as well less capacity in the active space, but still some capacity there and that would really be across the entire family. So we can we can feed the beast, we have demonstrated our ability to do that as we see the demand there and that's really you know as we and we'll talk more about this as we get into our Investor day, we need to management and along the way. This is something that we've been building over time, we know what.
The peak looks like in terms of full penetration of responsive we know where we are we know what the business comes our outcomes are associated with it and we're going to give a much more granular perspective about where we are and where we're going on this but we do have the capability to put units into the business in many parts of the business right now I was going through some numbers. The other day and athletic also and they've had an incredible bottoms business and the power being a fabric and thats really been based on buying conservatively, but then a near season in season response capability, that's allowed us to grow that in a way into the double digits season over season over season.
Yes, I'm pretty optimistic quite honestly about.
Navy's Q4 comp we've got the fuel there to do it we've got the response of capacity I think were planned well.
But again I don't want to call. It right now I just want to deliver it.
Great Best of luck.
Thank you we'll take our next question from Omar Saad with Evercore ISI.
Thanks, guys. This is that when a recovery said on for Omar.
You recently have brought in and outside creative agency on us.
Leonardo.
Funding for the first time in several years.
If you think about.
Running that internally versus externally, it's been sending a new CMO.
How do you integrate those has that changed the process as you integrate the strategy and looking at the new campaign seems to be really focus on denim denim is really a focus category.
Multiple places what where do you think you need to do to really emphasize the strength in the heritage.
Gap, then I'm kind of going forward to make it stand out and when that customer back. Thank you yep.
Yes. So you are correct that we brought in jail.
Really they and our new CMO kind of came in midway in the process and I'm going to be just completely just get it off the top of my head on this one honest with you which is that is always a little scary to do especially for big season, like we had with fall, we're really re launching denim and coming out strong and proud about denim.
You'll be you'll be the judge on the content.
If you see the 62nd anthem, It's then cut down.
Two six second already down to six second product post videos for social I was super pleased with how a leg right as our CMO and the agency got up to speed and really understood. What we were trying to do and balanced the need for a brand message along with a need for a call to action to get in our stores and try our product on.
And it makes me feel.
Pretty optimistic because I've been through agency startups before pretty optimistic about what we can get done as we really start to season and with each other.
And they get dial then I will tell you because you called it out that on my mind, absolutely is more aggressively mining the heritage and the legacy of the brand to our consumers tell us that is something that they want to connect to and that they want to understand take a look at the denim through the ages that weve done there's splay of that's a few stores 17th Insys has as where we've also brought products that we've modernized out of the archive and customers are loving it and I'm always one of my measures is how much of that I'm seeing in the building and I'm seeing a lot of it in the building. So we think that is a very very deep vein that can be mined I know jail feels exactly the same way about it as well and they are already building that into some ideas for our holiday campaign and as we get into spring and summer next year.
And as you know the CMO came from Adidas a lot of the research a lot of the resurgence there really came out of reassorting the legitimacy legitimacy in the relevance of the brand based on the heritage of the brand and we're not we're not copying that playbook, but there's a lot of good ideas. There I think that absolutely apply to gap brand as well.
Five does look good and I wish you luck on the campaigning going forward.
Thanks, guys. Thanks.
Thank you we'll take our next question from Ike Boruchow with Wells Fargo.
Hey, good afternoon.
Sorry, I think for you I think you mentioned.
Some marketing pullback or maybe it maybe as art some marketing pull back when you saw the demand in the product wasn't really there.
In the second quarter.
I mean, you can kind of see in the upstream. They line up just my question when we think about yesterday.
Are you pushing some of those marketing dollars into holiday, meaning should we kind of expect the SGN a growth.
Maybe tick up a little bit when we get into Q4 was kind of curious how those marketing dollars are shifting around.
Yes, let me clarify that I will turn it over to Terry because that was the big one really was and.
Intentionally going pretty dark with gap brand really in the first half.
And we saw a direct connection to that and traffic marketing does matter with the intent being that we would return to more normal marketing levels in Q3, and you will note that we have an adult campaign social campaign shot separately, but related to it and then a kids and baby campaign, which we haven't had for a while and so far the early returns have been very very encouraging I'll, let terry talked about but the specifics here, but for GAAP. It was really a return more to normal than it was sort of an acceleration or anything like that within intentional dark period over the over the bulk of the first half.
And again as we look at the back half and we will have some I would call a modest uptick in advertising that you won't see any M&A line.
Asking for the reasons are described we've talked about in terms of matching it with.
With the product improvement there will also be.
De leveraging question as you remember in the fourth quarter of last year, we had.
Adjustments to our bonus accrual that came through and obviously as we established that this year kind of pressure on the back half as well.
Thank you.
Thank you we'll take our next question from Oliver Chen with Cowen and company.
Hi, the banana Republic, adding rental subscription service sounds quite innovative what are your thoughts on re commerce and rental subscription.
Also as we are doing a lot of work on the circular economy, what will be your your guard rails and framework for thinking about success with with the rental subscription banana Republic and how might this supply to your larger framework for the other brands and how you see customers focused on sustainability and what that means to them.
It was a it was a very rich very rich question Oliver Thank you.
So the subscription service, let me start there we are looking at it at the moment as a customer acquisition opportunity.
And we're doing some pretty rich thinking I'm pleased with how we think about customer acquisition the role of our stores and how does how does a satisfied customer in the store less a 20 minute immersive experience and what would we be willing to pay for that and it helps us think about the value of our stores beyond simply the pure momentary four wall contribution, but also things like this a service like this that gives customers the ability to participate in the brand with less of a permanent financial commitment potentially so we'll read it and first and foremost we're going to look at customer acquisition metrics can it grow into being a significant and profitable business. The economics certainly work it'll just be a question really of what the uptake is as we get a dial that so starting in banana and given the price points and given the U.S occasions does this have some applicability of the other brands it might.
It's interesting in my mind to think about.
Right now with the with the newborn newborn with a two year old house sort of it's not minus my daughters.
How fast babies go through close as well and how many of those close either wait to get handed down or turned in is there something interesting. There also so really looking at it and we thought that this was a good place to read.
And I am excited to see what the results are obviously were just kicking it off on the.
Sort of the resale and stuff like that you know we're watching all these things and we talk to everybody out there where I do believe there is an opportunity and we had some of this a little bit of the gap brand with some vintage items that were bought and then upcycle.
We do think there's a vintage play largely around our brands that were exploring and we have been buying some items out of flea markets and other places and bringing them in im not sure Theres a big.
Resale market opportunity for us, but our eyes are wide open and so we're looking at it the clearly sustainability is a huge issue.
And we're increasingly seeing that.
As we talk to our customers, we think we have an excellent.
Sustainability record and we know we can do a lot more and we intend to do a lot more.
I think as you've probably heard me say before one of the biggest elements of waste in our industry is the is not but not the clothing. That's bought it's the clothing that is bought that unwanted and the long tail that we and many other companies have that end up sad and lonely in the clearance section of the store.
And the good news is that limiting that waste also improves our inventory productivity, our margins and our working capital efficiency and so thats another place, where we'll focus which I think people really don't understand but it's big economic driver for us and a big waste eliminator.
So you've got your arms around that issue, we think we're well positioned to really move on this and move aggressively obviously subscription service first within the whole issue of inventory productivity is kind of kind of the kind of the industry's dirty little secret that we're committed to tackling.
Thank you and a quick modeling question. So as we think about the back half you you had a nice Q2, which beat relative to Street estimates and then you reaffirmed.
Your EPS guidance, but has a lot changed as you are through the first half.
Versus your prior expectations in the first quarter as we model the back half.
Okay tell a lot has has changed really we actually had a little bit better margin performance.
In this quarter than we had originally expected.
But but as we've as we've modeled the back half, we there's a little bit of shifting I guess between Q3 and Q4, but generally speaking I wouldn't call out anything.
Notable and the change.
Thank you best regards.
We'll take our next question from Alex well this with Goldman Sachs.
Great Good evening and thanks, so much for taking the question.
I had a question about the impact of parents on the business you helpfully suggested that it might be around a six cents impact to the businesses on mitigated.
I was wondering if you seek to offset that how much of the six cents can be offset by pricing versus other strategies to offset.
If they're all price increase where you know in terms of categories banners are you likely to be able to take the most.
Price. Thank you.
Let me take a let me start and then I'll hand, it over to Terry as well there are.
Various ways to mitigated in the in the world of Geff.
Number one is sharing this with our vendors, which is where we're starting the conversation.
Number two certainly that Weve looked at is are there places, where we should be adjusting tickets.
And adjusting those either at the factory or in our Dcs or in our stores, we have to take the capacity to do all of that but I would also say is that.
By far the bigger lever is continuing to tighten up our inventories first and foremost that allows us to improve our yields and reduce our promotional intensity.
And recover it that way as well.
And again Weve tried to be really forthright about this and play it right up the middle in terms of what we think the impact is we do think that we have ample levers to mitigate this obviously, our first and foremost would be that that we get into a more predictable environment, where we are sort of constantly being whipsawed by what's going to happen tomorrow.
But we're very flexible and we can deal with it as it comes along we have a bunch of levers to deal with it you want to add to that Terry I think you've covered about okay.
Great. Thanks, so much and then maybe one more from me.
Leaning into denim at both the gap and old Navy brands can you give us some color on your how big denim is for those brands at the moment, how big can it get.
Has that been material variance over time and the importance of that category within your assortment.
Yes, we don't I don't really see a limit frankly old navys continued to gain market share in denim and still has.
Single digit market share.
And GAAP had significantly more market share before the sales issues over the last couple of years and so we have seen denim penetration inside that business substantially higher so I guess my my starting point with GAAP has to say, what's our fair share and where we've been even recently and we're well below that.
And we know we have us already and we've done the customer research, we know what our functional emotional equities are we know where people connect with the brand. We are in an interesting denim trend cycle right now with the diffusion of trend across rise like shape and silhouette, you would see us aggressively embraced that inside of gap and were seeing her respond to that and it's a it's a real great opportunity. Our tagline is denim our denim now and we're really trying to focus on denim for all including inclusive sizing that allows us to reach up to a larger size customer.
So I don't I don't see a limit.
We've also been in a cycle, where denim has been in a bit of a bit of a flat cycle, which has always historically been then followed by.
Something that really motivates the consumer to get out of offer couch and into the stores and we're seeing some of that right now in lake shaken rise certainly, but we anticipate that we're going to see some trends emerging in the springtime that are going to play into our denim.
Our denim authority, so I'm excited about it and its a loyalty category and last thing I would say is on gap.
Is that we knew we were having issues on fit consistency and with this new flow again early days, we're seeing the ratings online et cetera to be quite positive in terms of how she feels about the fit which is always a good indicator for us.
Thanks, so much.
Thank you we will now take our final question from Lorraine Hutchinson with Bank of America Merrill Lynch.
Thanks, Good afternoon.
I just wanted to follow up on the comments that you're continuing to work on the third quarter inventory are there particular categories or brands, where you feel like you are still too heavy or have you been able to get into chase mode.
And.
The back to school season.
All right I would say that we still have opportunity in each of the brands, obviously leasing athletic just given their inventory productivity continues to improve.
As they leverage their capabilities and frankly have strong growth tailwinds behind them.
But as we look at each brand and when we set the floor is our productivity has declined and in a time when we've invested in the many capabilities that are has mentioned, we really wouldnt that much higher standards for our ability to operate with leaner units and not Miss a beat in terms of demand as we can chase into it frankly with centers with better styles and better knowledge about what that demand is not just quantity, but but also trend. So so I could see opportunity linearly across the brands I think.
Specifically going into the back half.
What we would see primarily is that.
Old Navy and at gap brand, probably have the opportunity and can move to other carryover units and make sure that they are best positioned to be able to capture the product improvements we see in the fall.
But it really is across the brands I just add to that that as we said both Terry and I, we do feel like we exited the quarter in pretty good shape. We are focused on clearing I don't think you would say Terry you feel like we're super heavy anyplace else, but we aspire to a higher standard in terms of inventory productivity is just isn't where we need to be and we know we can do better right now, but I'm not concerned about as I said I'm not concerned about about waived liability that we're going to be fighting our way through during this quarter. No. In fact, I think what we have been encouraging is to see any organization embrace that as we think about how do we how do we think about differently. How do we drive accountability in different ways. There is a huge receptivity to the ability to better leverage than we have.
Thank you.
Thank you that does conclude todays question and answer session as well that does conclude our conference.
Thank you for your participation and you may now disconnect.