Okay. So thanks everyone for joining us. Wells Fargo Consumer Conference in Laguna Beach. Really want to thank GAP for GPS GAP, I don't know what to call you guys. It's called GAP.
Terry Stoll,
Terri Stoll, Executive Vice President and Chief Financial Officer. Thanks so much for being with us. A lot of questions, obviously, on everyone's mind. A lot of them kind of around the same topic. I guess to kind of kick everything off with this fireside chat, let's just the rationale behind the separation of Old Navy and Gap.
I understand that you've said the separation will allow for more focus on each company. But could you just kind of maybe help us what specifically does the separation enable that could not have been accomplished when we were just one GPS, just one off everything together?
I think that is one of the key questions we keep getting. And to your point, we do believe there is a compelling strategic rationale for separation and focus is a big part of it. It will provide enable both companies to really amplify their areas of respective operational strength. It also we talk about it as being a catalyst, a catalyst to realign the operating models and really drive efficiency and a culture shift in both companies to create just a higher degree of accountability and delivery of results. And I guess the most important part is it really does allow them to each make capital allocation decisions that allow them to capitalize on the unique strengths and make the investments that can drive the growth that fits with their operating model.
And just to put it into a little bit of context, Old Navy is an $8,000,000,000 company and it's on itself 700,000,000 units. And it does that on the back of only 9,700 styles. So that means it sells 70,000 units per style. So you think about how many styles you have to develop, what's the vendor scale you have when you're going to have 70,000 units made of one particular style. It's a certain kind of business model that runs well there and a certain number of priorities that affect how you drive that business.
In contrast to Gap Inc, across that portfolio, there's only 425,000,000 units sold for about the same amount of revenue. But it's sold on the back of about 37,000 styles. So about 4 times the styles. And so it's just a very different business model in terms of how you staff the product engine, how you interact with vendors, how you think about logistics. There's just a lot of elements of the business model are different.
And then you take it to the next level and you say, what's the store experience at Old Navy versus the store experience at 1 of the Gap Inc. Specialty apparel companies? And an Old Navy store is 15,000 square feet. And when the customer comes into that store, they're expecting a certain experience that you get at Old Navy, but it's with a value orientation. Whereas when you go into an Athleta store or a specialty apparel store, it's a smaller environment, more like 4000 to 9000 square feet versus 15000 and you expect a very different experience.
And so as you think about those business model differences and then you say, well, what kind of technology do you want to invest in? What kind of customer experience initiatives do you want to invest in? What kind of supply chain initiatives do you want to invest in? They're fundamentally going to be different. And that is really what we believe the separation will allow is for both companies to really drive growth and profitability against their respective business models, which are fundamentally different and increasingly so over time.
So let's maybe break this apart and focus on Old Navy. So I think at your recent Analyst Day, you talked about some targets. I think it was 2,000 stores, dollars 10,000,000,000 in revenue. So pretty good goals. I guess the question is, how do you get there?
And more importantly, is there a time line you can help us understand how you go from $8,000,000,000 to $10,000,000,000
For sure. And I think that the $2,000,000 number could be a very aspirational number or could be a very concerning number depending upon the timeframe. And so I did want to provide a little more clarity on that. So the 10,000 sorry, the 2,000 gosh, 10,000 stores would be the 2,000 store number is really a long term goal. It was intended to demonstrate that as we've done our homework to map out where meaningful white space is where we have a proposition that could deliver profitable growth.
What could that look like? And at 2,000 stores, we think you would still be able to maintain good profit good contribution margins and not be oversaturated. But that is not a short term goal. That is not necessary to achieve the $10,000,000,000 The $10,000,000,000 plan is really more about the pace we're at about today. So in the last couple of years, we've accelerated the pace of our store openings.
So we've been opening about 75 stores a year. And one of the beauties of the Old Navy model is that its stores deliver a very nice contribution mid-20s contribution and a very nice cash on cash return. And as we've been accelerating the opening to 75 stores a year, the whole objective is to maintain that mid-20s contribution rate and that will be our barometer going forward is to maintain that same level of attractive contribution. And so as we've looked at the plan forward, it really is more like continuing that 75 stores a year. And we talked a little bit about that opportunity.
A lot of that today is just the model we know today with all of the demographic and competitive insights we have, just continuing that out. But we've also tested and found success in smaller markets. So these are markets that are less than 200,000 population and we've been open able to open there and deliver also the same attractive returns. The volume in those stores is a little smaller. The store size is about the same 15,000 square feet generally.
But because of the rod structure, we're still able to get the same kind of contribution levels in smaller markets. And I just I want to point out because there were some questions about it. This is not a micro market. So these are not 30,000 population towns. This is still meaningful population zones.
And many of these places the Sears, the JCPenney's, the Kmarts, these were unfortunately or fortunately destination shopping points in many of these locations and they're gone. And so, for Old Navy to come in and be able to serve the family apparel needs is a real welcome and that's part of how you can really drive the productivity of stores even in smaller markets. So that's hopefully clarifying in terms of what the 2,000 is versus the short term plan.
Right. So understanding the share gains and the growth opportunity in the top line, think the margins at Old Navy, I think you gave us, like high teens, 18% adjusted EBITDA margins. That's already pretty impressive and high. I know you haven't given guidance for, the direction of margins once the split does occur. But how should we think about Old Navy's margin structure?
Is that something that you'd be happy with if it was stable going forward? Is there actually post split? Could there be upside to that number over time? How do you think about profitability?
Yes, you're spot on. I think the EBITDA margin, the margin profile in general for Old Navy is one of the advantages and the cash flow generation that comes from that is super attractive. And as you put that up against a growth plan, which is a very reasonable growth plan, it is one of the things that is really attractive. If you think about the components of that EBITDA margin, if you start with the financial margin, Old Navy is a very scaled business and I talked about the number of units that are in that business. So that drive for efficiency, has been a focus for a number of years and they've done a really good job in sort of enhancing the processes and driving the supply chain initiatives and importantly the vendor relationships to really have strategic relationships that have given us some very good cost base.
But there's still more opportunity there for us to continue to drive that. So that will be one of the priorities that we have as we move forward. We've also got a lot of our internal product processes that we've continued to optimize, whether it's in merch planning or buying or our inventory strategies overall. And so we continue to optimize those and have had real good progress there in terms of getting a unit cost that I think is quite competitive in the market. So you add to that then a rent profile, which is very attractive, right?
The majority of the Old Navy stores are off mall. And so you have a much more attractive rod profile which adds to that more advantaged margin. And then the final component is store labor. The store labor model in Old Navy is, a lower touch model and that allows us to then keep store labor costs low. So those three elements then you bring together and you do get this very attractive margin posture, which we think is a competitive advantage.
But as we go forward, we'll obviously be continuing to work on each of those levers in terms of how we further optimize them. And so you talked a little bit in our Meet the Management Day about some of the priorities they have from an initiative standpoint is to really drive data and technology to be able to further optimize the inventory processes and be able to take some of the risk out of the business and be able to further optimize. So we're definitely working on that as a key opportunity as we move forward.
Got it. So I want to drill down a little bit more on Old Navy, but more in the near term. I think the last time you had to navigate through a difficult comp environment, it took you, just a few quarters. Is there anything different? I mean, obviously, Old Navy is having a little bit of trouble right now.
Is there anything different around what's going on today? Is this taking a little longer than what you would have expected? Is this a little bit different than maybe some of the past slip ups that Old Navy has had? Just kind of curious how you would compare this to historical issues.
Yes. You're right. The Old Navy business has been a little bit challenged. And this is a business that by definition you're not going to hit it out of the park every single quarter. There's good every single season.
There's going to be variability in the whole agenda is how do you minimize that variability, reduce the frequency of misses and reduce the depth of misses. And so we talked about this in Q1 and Q2. We started to see some of the challenges in Old Navy in Q3 of last year, became more pronounced in Q4, definitely got in and diagnosed the business. And it was probably a little more complicated diagnosis than it might be in some cases. There were definitely some product issues in women's.
We've talked about what those are. There were also some trend shifts going on that weren't necessarily really on trend for our customer. And then there were macro issues, right? We had weather issues. There was some consumer sentiment.
There was some it's just been a noisy place. And so the diagnosis was probably a little bit harder. But nonetheless, we've been working diligently at driving the product improvement. And we talked in the Q2 about how we were able to influence the Q3 product assortment We'll fully be able to address it in Q4. And so as we move forward, we continue to anticipate that we will see meaningful progress.
And we've also supplemented our plans with more targeted marketing, because one of the things we found, which as we went back and looked in history shouldn't be surprising is when you have this kind of a product situation, you do have it tend to have a little bit of latency and the traffic the return of the traffic tends to lag a little bit. And so we've been driving more targeted marketing to address the traffic. So those are coming together. And as I said, we expect to see continued progress.
Got it. So I have one more question on Old Navy. Just I think at the last event, Sonia talked about plans to triple the Old Navy employee base. Can you kind of talk to us about what that means from a cost perspective? And how is that modeled into the to everything in the separation?
Yes. That's another one that taken out of context could sound like a pretty scary number. So the tripling the employee base was in reference only to the headquarters employees, not to all of the store employees all around. So it but it's still a pretty big number. The way to think about it is that, there's 2 pieces where employees are going to be coming into Old Navy where they didn't exist before.
Some are associated with just standing up a public company and those are true true to synergies, right? They didn't need that before we had it at Gap Inc. They could fully leverage that and they didn't need to stand it up. So those employees will need to come in and that represents a dis synergy, one of the things that they'll be working to both bring in leanly, but smartly, but also find offsetting savings over time to address. The majority of the increase though comes from just bringing the center resources that support, technology and supply chain into Old Navy.
They've been supporting Old Navy, but they've not been housed in Old Navy's facilities. So that's really where the tripling comes from. And if I could just go back as we think about the Old Navy story, the challenges that we're seeing in the business today are frustrating and, they are, as I said, a combination of macro factors and self imposed actions that we need to address and we need to get much better at. But I think the important part is that doesn't in any way change our fundamental view of the power of this brand and the growth potential of this brand. And there's been some noise out there.
And so I just wanted to reiterate that when you think of the fundamental indicators of brand health and you think about the importance of the Old Navy brand in the retail apparel landscape and you think about the share that we've grown and yet the very small share position we hold against this really attractive margin profile and against this very achievable store growth plan. It's a powerful growth story that we have a tremendous amount of confidence in, in spite of a few quarters of more challenged results.
So sorry, I want to move on to Gap Inc. My favorite part of Gap Inc. Athleta, I think everyone's probably, but is there going to be some more P and L color on the remaining brands post spin, will you start to give us more insight into the profitability levels and EBITDA contribution from Athleta? I'm just kind of curious how you'll handle all that.
Sure. And we're glad you like Athleta. We love Athleta. If you think about the Gap Inc. Portfolio, we have our iconic brands like Gap and Banana, which have a series of opportunities and challenges, which are more focused on how do you stabilize those businesses and deliver profitability so that you end up with a healthier core from which to grow over the long term.
But Athleta is a growth engine just sitting in the portfolio and I think you've pointed out in the past, Ike, that it's not that important in the midst of the Gap Inc. Portfolio as it exists today with $16,000,000,000 of revenue. But in the new Gap Inc. Portfolio, it's meaningful. And our intent is to be able to provide enough transparency that investors can understand the components of the portfolio better.
I don't think we've done as good of a job historically as we maybe could have in this regard. And so we haven't finalized our full disclosure framework for Gap Inc. But the intent will be to provide more transparency so people can understand the growth we're seeing against the $2,000,000,000 growth plan that we have for Athleta, but also the profitability it generates. So stay tuned.
Got it. And speaking of Athleta, I saw yesterday, I think press release hit, you have a new leader of the brand. Can you elaborate a little bit on that?
We do. We do. So Nancy Green, who had been running the brand for a number of years and did a fabulous job bringing us to where we are, has gone over to be the Chief Creative Officer for Old Navy, which is a really important role for that brand. And we've been super fortunate to bring Marybeth on. We announced it yesterday.
She has an incredible set of experiences from great brand experiences most recently at Sephora, Nike, tremendous digital experience. And again, as you think about the growth path that we're on for Athleta, to have someone with Mary Beth's experience come to a leadership team which has all of the institutional knowledge and passion for the brand, it's just a really nice fit in terms of bringing new talent in that fits very much with the strategic priorities of the brand.
Got it. And then just on the profitability of Gap Inc. Now, the total new business. So I think you've told us it's a low single digit margin business, but then we have to factor in one time cost and dis synergies. I guess my question is, will new Gap Inc.
Be profitable at the time of launch?
Yes, great question and not surprised people are asking. If you just step back and just think about what is Gap Inc, the new Gap Inc. It is a portfolio of really great brands, very iconic brands that have, great brand recognition, but they're in various stages of growth and profitability. As I said earlier, our focus is to really rally those iconic brands and deliver profitability and then drive Athleta's growth path to $2,000,000,000 But you have to keep in mind, this is a large company, right? There's $8,000,000,000 of revenue.
There's 32,000,000 known customers and there's a healthy and growing online business that is there as well. But it also is a 50 year old retailer and it has all the legacy systems and processes and cultures that go along with that. So what we're very much focused on as we move through the separation is how do we start with using this as a catalyst to really drive a reinvention of how those brands operate. Today, we literally have a different operating model for every single brand. And even though we've invested in capabilities, because each brand operated a little bit differently, they didn't actually leverage the capabilities that are there and they certainly didn't do it with the efficiency that we can do it going forward.
And so what as we move into the separation, in addition to getting strategic clarity on what each brand should be focused on, we're going to be using that catalyst to really drive the cost savings and create a much leaner structure. And that will be a big factor in how we drive really multiples of profitability in a very short period of time as we move forward for that brand. The other thing to keep in mind is that the historical EBIT numbers and EBITDA numbers don't adjust for the store closure, the specialty fleet optimization that we've announced for Gap Inc. And we've talked about that as we move through those store closures, that alone is about $90,000,000 of benefit. So we need to build that into the model as well.
So, last thing I would say is that our intent as we stand up these 2 companies is to ensure that they're both positioned for success. And that means not only with the right strategies and the right capabilities, but also the right capital structure and the financial strength, which I think has provided Gap Inc. The stability that has needed to both invest ahead and have the capabilities you need to compete effectively, but also weather the storms. And so that will be our intent with both of these companies as well.
Got it. Super helpful. So the last topic I want to bring up is separation related questions, which of course is the fun stuff. I guess, can we talk about the one time cost you've laid out? My question is, is that all cash or some of the cash versus non cash?
And then in terms of timing, how should those costs hit and how should we expect them to be kind of allocated pre and post spin?
Sure. So maybe I'd start to preface it by saying that, these costs are largely in line with what we had estimated as we first evaluated the decision to separate the companies. So there were no big surprises in terms of the total amounts here. Certainly, some components were higher, some components were lower, but generally we netted out in the range of what we had originally expected. Yes, most of these are cash costs.
They will largely be incurred in 2019 2020, although some will inevitably tail off into 2021.
Got it. And then the different I was wondering the difference between restructuring and one time costs, how do we think about that?
Yes. Yes. Those are those can be confusing. For us, we've tried to keep it pretty clear internally how we think about it. And as we report externally, the restructuring costs are those costs that are related to the specialty fleet optimization.
So that's what's in that bucket. That was announced in advance of the separation. And then the separation costs are truly only those costs that are a direct result of the separation decision.
Got it. On the timing of the dis synergies and the mitigation efforts, a question I've gotten a lot is, are the dis synergies going to happen immediately? And then is the mitigation kind of come in years after that? So how do we think the timing of both of those dynamics?
Yes. It's funny at the Meet the Management event, I said that this was going to be a bit lumpy that this is not going to all come in, in a nice predictable streamlined way. And I think some people took away from that exactly what you described. Oh, that means we'll get all the dis synergies and then the synergies will come someday. And that actually isn't the intent, the plan.
And definitely we're still we're working through this, right? We don't have the full separation plan complete. So we're refining our estimates and we're trying to keep investors posted as we know more, learn more. But the intent really is to drive as aggressively as we can against the mitigation efforts. So we can to the extent possible be able to have as many of those in place on day 1 as possible.
But the dis synergies will come on a more spread out basis. So some dis synergies might come at day 1. So we talked about standing up a public company. That's a dis synergy that's going to exist on day 1. When you have to license 2 enterprise systems on day 1 that you previously only licensed 1, that's a day 1 dis synergy.
But dissynergies that are going to be in TSAs because it's going to take us a little longer to disintermediate those like some other parts of the technology platform or some pieces of logistics system. Those dis synergies may not come through until we get into the TSA or maybe even at the end of the TSA where you end up with more stranded costs. So when I say lumpy, it isn't intended to mean that the mitigations are going to come lagging. Our intent and our objective will be to get as much of the mitigations in place as soon as we can. And then the synergies will come as they come.
And as we get better clarity on those, we'll provide as much transparency as we can.
Got it. Also at the investor event, you mentioned approximately $100,000,000 of one time separation costs were related to, I think you said acceleration of an already existing modernization plan.
I hate transcripts.
Well, I guess what makes these costs one time in nature is my question.
Yes. And I understand how it can be confusing. So the $100,000,000 we referred to were they were their expenses that were on our roadmap for the future, just necessary modernizations that were going to have to occur, but they weren't budgeted. So they weren't in our existing plans in the near term budgets or forecast. And so, as we were thinking about how to execute some of our technology separation, there were just logical places where rather than cloning an old system, you would go ahead and modernize that system.
And so it's an acceleration in that someday it would have happened, but it's a one time cost because it wasn't in our base forecast or near term budget plans. Does Does that
make sense? Yes, definitely. Can you provide a few examples of mitigation efforts since we've brought up that topic, that are specific to the separation? Could any of these been put into place without separating the companies? I know that question comes up a lot with investors.
And then I guess if so, what's going to kind of give you what gives you the confidence that the spins really necessary to bring these changes to the business?
Yes, it's a fair question and it's true that in theory many of these efficiency efforts, these mitigation efforts could have been implemented. But I talked about the difference in the business models that exist And I talked about the culture that 50 years of operating as a retailer with these collection of brands can bring. And it really just is an enabler. I mean, I use the word catalyst overuse the word catalyst, but it really is an opportunity for us to really for both companies look at standing up Old Navy quite fresh clean sheet of paper creating in many cases these processes. How do you want to do a clean sheet of paper?
And then on the GAAP Inc. Side, the challenge, the strategic imperative to reimagine how we work and to do it in a much leaner way and think about what work should we reengineer and do quite differently? What work should we just eliminate completely? Where can we live without things that we've become comfortable, but haven't really needed to have? There's just like a limitless opportunity of places where we have room for efficiency.
And in the Gap Inc, the new Gap Inc world, it really is, a function of driving a standardization and platforming that we haven't been successful in doing in the past in part because the Old Navy demands are different than the rest of the business demand. So now when you have more homogeneous business models, more homogeneous brands, more homogeneous customer base, the ability to really drive that platform mentality and mandate standardization and really drive accountability for that is just it's enabled. So could it have been done without? Sure. Again, I come back to we didn't do the separation, so we could rationalize the cost structure.
It's just a really nice corollary benefit we need to take advantage of, to be able to set both companies up for success.
Got it. So a couple of more questions. Any thoughts on the capital structure of each of the businesses? And then kind of what's the thought process that will kind of drive whatever strategy you guys kind of think about when you kind of think about capitalizing both those businesses?
We're spending a lot of time trying to do a thoughtful analysis on both capital structure, but importantly capital allocation. And we don't have final decisions. What we're trying to balance is what is the right with the right mix. Our fundamental priorities haven't really changed, right? Our primary use of cash is to invest in the business for growth.
But we have a long history of providing a return of cash through a combination of dividends and share repurchase. And we would expect that to continue frankly for both companies. And the question is, what is the right mix? What is the right mix of cash return that appeals to the target investors? And what is the right level initially on a going basis that fits the strategic priorities of each business.
So more to come on that, but as I mentioned earlier, one clear objective in terms of capital structure is to ensure both companies are stood up with a good strong balance sheet and sufficient cash flow to be able to support the needs of the business and provide a return to investors.
Got it. My last question is, what's the most exciting to you right now kind of going into the spin? And then I guess, same question coming out of the spin, what will be the most exciting thing for you?
Yes. Well, in the midst of the spin, excitement probably wouldn't be the word that I use. There's a lot of work going on and it's making great progress, but it is a lot of work for sure. What we cited about post separation is what I love about our company is our brands. And we have such an amazing complement of brands.
And we look at them today and we know they're not performing as well as they could or should. And I'm super excited about the separation being the instrument that allows Old Navy to really thrive and to single mindedly focus on its mission to drive the growth of that brand. And conversely on the Gap Inc. Side, I mean those brands are so iconic. And if I think about my experience since I've joined the company and anywhere in the world I go and I tell people I work at Gap and they immediately go to Gap brand and they say, oh, I love the Gap brand.
I remember this event or that event or this event. And it's always such an emotional reaction. And so I always follow-up with the second question of, great, so do you shop there? Not as much as I used to. And so what excites me is really using the separation to get those brands all of them to the strongest footing, so that any of those brands when you ask a customer, do they know it and do they shop it, they say absolutely with the enthusiasm that they remark on their experiences with Gap Brand over the past.
So, super excited about setting them up for success and making sure we can deliver on that promise to our customers and frankly to our investors.
That's great. Teri, thank you so much. Sure.
Thank you, Ike.