All right. Thanks everybody. It's now 2:30. Again, thanks for coming to our 10th Annual Consumer Conference in Nantucket for Jefferies. Again, I'm Randy Konik, the Consumer Lifestyle and Growth Platforms Analyst.
And now my 10th year at the conference, so continue to love it here. I guess the rain is putting a little bit damper, but let's keep our spirits up and let's get ready for the clambake later this evening. So we now have Gap with us today, lots of interesting things going on at the company. So wanted to have a conversation with Terry Listole, the CFO of the organization to kind of give us some perspective on different facets of the organization. So I'm going to start off, Terry, thanks for coming.
No, I appreciate it. Sorry about the weather, but we'll power through, right? I just want to start off with, let's talk about Old Navy, a crown jewel type of business, had a little difficulty in the most recent period. Give us some perspective on progress being made at that concept as we get the business back on track and get people thinking about the long term opportunity for the brand?
Yes. Happy to start with that question because it is an amazing crown jewel brand for Gap Inc. And as a standalone company as we prepare for the separation. We remain very confident in the future of the brand. It is a healthy brand.
And the results that we saw in the Q1, while not what we expected the brand and not what we know the brand is capable of, do reflect a combination of factors, right? There was certainly the weather that we and others talked about. There were some macro factors. And then there were the things that were we call them the self inflicted challenges that we face. And those are the ones that we've really been focused on to bring the brand back to the strength that we know it's capable of.
The big thing is product. We did identify some issues, particularly in our women's product. And we have taken some actions to address that. We'll see that start to show through in the fall assortment. And then we're fully in holiday where we've had the chance to actually design the entire assortment with the changes in place.
So we feel very good as we look forward on the business. The good thing about the brand is it continues to grow share on a rolling 12 month basis. It continues to be an amazing strong brand number 2 only to Nike. And the YouGov and NPS stores, which are measures of customer reaction to the brand remain very strong. So all the fundamentals are good.
We've taken the actions. We feel good about what we'll see in the back half of the year and certainly a long growth runway ahead.
Great. And when we look at the Gap business, the Gap brand business, if you will, one thing that was interesting about the last quarter is it appeared that gross margins in the Gap brand started to kind of stabilize, if you will. So just what's going on there? It seems like maybe it's while the comps are not great, the business is starting to see at least from a margin profit margin or gross profit margin perspective seeing some sort of a footing. But what's driving that?
What's going on there? It should be helpful if we get some perspective. Yes.
And you're right. What we saw in the Gap brand is what we do want to see in the Gap brand, which is a focus on improved profitability. So to see the gross margin rate improvement was positive and it is what we were largely expecting. To your point, the negative comp is not what we want out of the brand. In the short term, particularly as we have these macro factors sort of getting us to a situation where the inventory is not where we want it to be.
We do want to keep that focus on driving the gross margin and keeping the inventory clean. So even though we exited the quarter with a little more inventory than we would like, we do feel good about the quality in terms of the liable percentage. It's really the quantity. And so we'll continue to work through that in the Q2, but with the same focus of how do we regain some of the margin rate on the brand, because the role of the brand in the portfolio clearly is to grow earnings. And we have a number of actions underway for that brand as you well know in terms of the specialty fleet restructuring, which is underway, which is an acknowledgment that at the end of the day the Gap brand needs to get back to a smaller healthier core from which to grow.
And so that's a key element of this. And then a lot of the operating model fixes and you'll see these more as we get through the separation and we talk more about the new co strategy, how that operating model will come to play on the Gap brand to both give us a leaner cost structure, but also a more consistent delivery of the great products that the Gap customer expects and that we frankly haven't consistently delivered.
Got it. So very helpful. I want to move on to Banana. So Banana, it seems like there's been progress made there around margin, customer base, etcetera. What's going on there?
Just give us some perspective on what's going on to help that's helping to have that brand become more healthy and moving in a right kind of in a better place?
Yes. It's always kind of fun to walk down the brands because then you realize just how fortunate we are to have each of the brands in our portfolio despite having opportunities for each of them to improve. Banana has a real place, I think in not just our portfolio, but in the lifestyle of a meaningful customer base. And I think we are very pleased with what we are starting to see in that brand in terms of turnaround. Obviously, again, the Q1 comp wasn't what we wanted to be, but it's not in our view indicative of the fundamental health of that business.
We have seen quite a turnaround in terms of the quality of the product, the on trend nature of the product, the customer reaction to that. And so for me, banana is really just more of the same. Keep moving on the turnaround that we started to see the progress from. It is a nicely profitable brand. And one of the things we did a few years back is to help people understand that there is a really nice margin profile there, But not unlike the Gap brand, our primary priority is not top line growth at the moment.
It really is to regain even more profitability to drive the margin expansion, while getting positive comps in the business. So we're seeing the fundamental product come to life. The marketing efforts are coming to life. The customer is reengaging and I feel good about what we'll see from that brand going forward.
That's good. And then to round it out on the brand side Athleta continues to be a very solid, strong, positive, great story and growing nicely. It seems like the stores store growth story is coming back to light. Give us some just perspective on what's going on at Athleta and just kind of the real estate strategy there, if you will?
Sure. So Athleta is a gem of a brand. We love to talk about Athleta and we actually probably don't talk about it enough, which is an opportunity we have with NewCo because obviously Athleta will be a bigger part of the portfolio and we'll get more visibility. And as we do that, I think what you'll see is that there is a really nice growth runway for that brand. It is in a very advantaged space.
It enjoys and cultivates a very passionate, loyal customer base. That's probably our most affluent customer base. And so we think about the real estate strategy, I guess, which was your specific question, as one where we have quite a bit of runway for new stores. They're much smaller stores and we have a unique real estate strategy that we pursue there. We have about 165 stores now.
We've been opening 10 to 20 stores a year. I think that's a responsible runway for that brand. I think you could pick it up. But I think we also have opportunities for other avenues of growth. If you remember Athleta is our most highly penetrated e commerce brand having started from a catalog business.
And so the specialty channel, the e commerce channel, there may actually be opportunities in outlet or franchise for Athleta. So there are a number of growth avenues we can pursue going forward. And I think playing in an advantage space and continuing to pursue that largely as we have done, we don't see any major changes because frankly the model is working. Now every brand has hiccups now and then. We had a few hiccups in the Q1, but fundamentally see a lot of growth.
Good.
I want to jump to inventory and just think through your views of inventory coming out of the Q1, I think, is a little high or I don't know if that's where is that by brand, if you will, if you can give us some perspective there? And just kind of how we should be thinking about inventory as we progress through the year?
Yes. The inventory numbers that we talked about this in our quarterly earnings call, we're not pleased with where we are in inventory. We exited the quarter heavier than we would like, particularly in this current macro environment. The reported number was a bit high because of number of reconciling items. So if you take those out, we ended the quarter at +5.
Okay.
And that's higher than we want to be. And it's obviously, we talked about the slow start to Q2 and with the weather in May. So we found ourselves again in a situation where there's just too many units in play, which dry and it's not really just us. We're seeing that same dynamic too broadly across our space, which drives a really difficult promotional cycle. And so our focus is to move the units through protecting margin as much as we can, but putting a priority on exiting Q2 clean in terms of again of liable inventory.
And then really in the back half, we've bought much leaner, much tighter. Old Navy in particular, we gave some color in the earnings call about being down in the 4th quarter mid single digits. So that's the strategy, particularly in this macro environment is to be as lean as possible and then chase into demand as it materializes. And that's not the way we started the year. It's not the way we're starting the Q2.
It's the way we have to play out the year and that's how we would expect to then deliver the margin progression in the back half.
Yes. I want to kind of touch on that if we could, the gross margins. We've gotten a more subdued gross margin outlook obviously then for the Q2. Just how should we be thinking about the gross margin dynamic throughout the year just holistically?
Yes. The 1st quarter dynamics that we saw are likely to play themselves out not too dissimilarly in the Q2 because of the same factors that are affecting it. So but as we get to the second half because of the things I talked about in terms of improved product at Old Navy, continued progress on the Gap brand, leaner inventory levels overall. We should and then of course we're anniversarying weaker base. So those are the primary factors when we think about our second half guide to get to the full year.
Those are the things that we think drive it.
Got it. One question we get from people is thinking through the separation work that's been done. Any distractions or day to day with that that's gone on or not gone on at the company? And how do we think about those separation work that's being done?
Yes. The separation transaction is it's big. It's big news. It was big news to the employees. It was big news to the investment community.
And it is complicated to be able to execute a separation. So the way we've tackled this to make sure that we distract as few people as possible is we've created a project management organization that is solely charged with the work of separation. And actually we have 135,000 employees, about 100 are in this project management office, which is really driving separation. So the whole intent is to keep people focused on the primary goal, which is to deliver the business on the year. They're all incented to do that because that's what their bonus is based on as well.
So their bonus is not based on how well we do the separation, it's on how well we deliver the business. And so we are confident that the structure we've set up has allowed us to minimize the distraction of separation. But there's no question, there is people are talking about separation, wondering how it affects them, etcetera, etcetera. And so we're trying to provide as much communication to the organization about where it stands, so they can not worry about that and just focus on the day to day business.
Got it. That's super helpful. When you look at the upcoming spin at Old Navy, there's natural potential inefficiency with that business and there's been obviously some challenges in the Q1 with the weather, right? How do you guys think about driving your productivity improvements as the spin occurs? Just give us some perspective there.
The productivity efforts that we talked about, I guess, starting a little over a year ago and we threw out a number of $500,000,000 of savings we thought we could get. And at the time, I thought there was more than that, that was even possible. And we tracked ahead of it almost from the get go. So we've made some really good progress. So what we're doing now in the separation time is making sure that we don't take our eye off the ball, that we continue to drive the same actions that delivered the first tranche of savings as we move through the year.
And we have good line of sight. So whether it's our sourcing or we have a team called the lean team internally, which is solely charged with helping us to identify cost savings opportunities. We've been conducting what we call gapathons, where we literally just bring people together to brainstorm processes that exist today to think about where is there waste in that process? How can we get cost savings out of some of the things we do? And when you're a company like us that is 50 years old, you accumulate a lot of legacy processes.
And when you get these people together in a room, which are all levels, so we bring in this group of people and we say check your level at the door. We don't care if you are a very junior employee or a very senior employee. Everyone has the same voice. Let's just talk about what it is we're doing that is hard in whichever particular area is the focus of the GAP A THON. And we found some really meaningful learnings that will allow us to reengineer a lot of processes, where today we are too detailed or we're doing things that we don't even know who customer for the work is anymore.
They've just been, as I said, legacy processes that don't add value in today's business. We also have identified through that a number of areas where automation should be a real enabler. And it's a part of what both companies are looking at as part of the separation is how do we leverage data analytics, machine learning, automation to drive not just efficiency, but fundamentally better processes, whether it's from trend identification to assortment to allocation in the stores. How can we use data to be more predictive to be able to eliminate waste in our process. So that's a big unlock for us and we're using it to drive productivity today and then as we think forward to the separation.
Very helpful. Let's talk, I don't want get bogged down in accounting, but let's talk about I don't want to get a headache.
Yes, exactly.
But let's talk about lease accounting. How has that had a change in impact in the business change in impact and what do we should be thinking about those items there?
Yes. So we adopted the lease accounting with the Q1. We disclosed all of the impacts of that in our 10 Q and I think even with the earnings call we had a great deal of detail. For as much effort as has gone into adopting the lease standard and as much impact on the balance sheet because it's grossed up the balance sheet dramatically, it hasn't changed our fundamental leverage assessment. So the numbers that were used before are the same numbers today at the end of the day, which I guess is in some respects affirming that a simple rule of thumb, X times rent gives you about the same answer is a very complicated accounting model.
But nonetheless, I think the information that is now contained in our balance sheet is reflective in a very precise calculated way of the lease obligation. We do think of that lease obligation as different than funded debt. But nonetheless, all the information is there between the balance sheet and the footnotes to be able to understand exactly what the obligation is. Okay.
We're asking this question of all the companies just say one word tariffs, what's latest and greatest there that we should be kind of thinking about from your perspective for your company?
Yes. The tariffs definitely represent a big uncertainty that's kind of overhanging everyone. We don't like tariffs any more than anyone else, but we actually do feel like we've been asked a couple of times, well, what's your playbook on tariffs? And we actually have 2 elements of the playbook. 1 is to continue to reduce our dependence on China as sourcing.
Today, in our last 10 ks, we disclosed 21% as the amount sourced from China. And that includes accessories and other things. So the actual apparel numbers is closer to 16%. So on a relative basis, we are not in a terrible position because we've been really moving away from China to other countries for a number of years now and we will continue down that path. There is a core element of items that are sourced from China that actually can't economically be sourced from anywhere else.
So we're going to be stuck with that. And that's where the second part of the playbook comes in, which is we need to figure out how to recover any tariffs that might be imposed. And we will do that through negotiations with vendors and other identified ways to reduce the associated AUC of the product. And then at the end of the day, we will be forced to pass that on to customers through price increases. And we'll do that in a smart way.
It's not going to be in a blanket way that we'll do our best to mitigate any volume impacts from increased pricing. But it is a cost, it is a real cost that ultimately will be borne by the customer.
Helpful. These two other areas of the business that are interesting, 1, the Genie and Jack acquisition, and then second, the launch of Hill City, just give us some perspective on those. What could though what are you looking at those strategically at for just give us some perspective?
They're both very interesting brands for very different reasons. So we bought Jamie and Jack quite opportunistically in the Gymboree liquidation. It was we weren't out looking for kid baby brand, but lo and behold, Jamie and Jack is actually a very good fit in our portfolio and at a price that we feel very, very good about. So we see that as an opportunity for us to access yet another complementary customer base that fits very nicely with the other brands in the NewCo portfolio. We have a really nice kid baby business in the Gap brand.
Janie and Jack plays at a level a bit higher, very profitable store base, very small brand at the moment, but one that we think has nice growth potential as we move forward. So we're excited about the addition to our portfolio and what we'll see in that over time. The Hill City brand is very different because it is a brand that we launched digitally native brand that we launched on our own. It's a men's performance apparel brand and we hatched it out of the Athleta brand. And it was really a bit of an experiment for us in terms of how can we best leverage our scale and our product operating model to potentially create brands as opposed to acquire brands.
And this is a lucrative space. It's an underserved space. And we were able to launch quite quickly by leveraging a lot of the talent and capability that's within the Athleta organization. Now it's early days, doing fine. We'll see.
We didn't expect it to be a $3,000,000,000 brand. Time will tell, but we are really fortunate to be able to use this as an experiment in a learning vehicle. And we are actually quite optimistic about the reaction to the brand and in particular the things we've learned in launch that will be applicable not just to our existing brands, but should we ever have additional brand launches.
Really helpful. We've run out of time. So thanks, Teri. Really appreciate your participation and thanks everybody for listening. Thank you.
Thanks, Randy.