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 Randal Konik, the Consumer Lifestyle and Growth Platforms analyst. Now in my 10th year at the conference, continue to love it here. I guess the rain is putting a little bit damper, let's keep our spirits up, let's get ready for the clam bake later this evening. We now have Gap with us today. Lots of interesting things going on at the company. Wanted to have a conversation with Teri List-Stoll, the CFO of the organization, to give us some perspective on different facets of the organization. To start off, Teri, thanks for coming.
No, happy to be here.
I appreciate it.
How about the weather?
Yeah, sorry about the weather. 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.
Yeah, happy to start with that question because it is an amazing crown jewel brand for Gap Inc. 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 first quarter, while not what we expect of 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. There were the things that we call them the self-inflicted challenges that we face. 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 more fully in holiday, where we've had the chance to actually design the entire assortment with the changes in place. 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. The YouGov and NPS scores, which are measures of customer reaction to the brand, remain very strong. 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. 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 stabilize, if you will. Just what's going on there? It seems like maybe while the comps are not great, the business is starting to see, at least from a profit margin or gross profit margin perspective, seeing some sort of a footing. What's driving that, what's going on there? It'd just be helpful if we get some perspective.
Yeah, 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. 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. 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 liability percentage. It's really the quantity.
We'll continue to work through that in the second quarter, 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. 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. That's a key element of this.
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 NewCo 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 product that the Gap customer expects and that we frankly haven't consistently delivered.
Got it. Very helpful. I want to move on to Banana. Banana, seems like there's been progress made there around margin, customer base, et cetera. What's going on there? Just give us some perspective on what's going on that's helping to have that brand become more healthy and moving in a better place.
Yeah. 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. I think we are very pleased with what we are starting to see in that brand in terms of turnaround. Obviously, again, the first quarter 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. For me, Banana is really just more of the same. Keep moving on the turnaround that we've started to see the progress from. It is a nicely profitable brand. One of the things we did a few years back is to help people understand that there is a really nice margin profile there.
Yeah.
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. We're seeing the fundamental product come to life. The marketing efforts are coming to life. The customer is re-engaging, and I feel good about what we'll see from that brand going forward.
That's good. 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 store growth story is coming back to light. Give us some just perspective on what's going on at Athleta and just the real estate strategy there, if you will.
Sure. 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 will get more visibility. 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. 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.
Yeah.
The specialty channel, the e-commerce channel, there may actually be opportunities in outlets or franchise for Athleta. There are a number of growth avenues we can pursue going forward. I think playing in an advantaged space, and continuing to pursue that largely as we have been. We don't see any major changes because frankly, the model is working. Now, every brand has hiccups now and then. We had our few hiccups in the first quarter. Fundamentally, see a lot of growth.
Good. I wanna jump to inventory and just think through your views of inventory coming out of the first quarter. I think it's 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. Just how we should be thinking about inventory as we progress through the year.
Yeah. The inventory numbers, 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. If you take those out, we ended the quarter at plus five.
Okay.
That's higher than we want to be, and it's obviously. We talked about the slow start to second quarter and with the weather in May. We found ourselves again in a situation where there's just too many units in play. It's not really just us. We're seeing that same dynamic too broadly across our space, which drives a really difficult promotional cycle. 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 liability inventory. 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 fourth quarter mid-single digits.
The strategy, particularly in this macro environment, is to be as lean as possible and then chase into demand as it materializes. That's not the way we started the year. It's not the way we're starting the second quarter. It's the way we have to play out the year, that's how we would expect to then deliver the margin progression in the back half.
Yeah. I want to touch on that if we could, the gross margin. We've gotten a more subdued gross margin outlook, obviously then for the second quarter. Just how should we be thinking about the gross margin dynamic throughout the year just holistically.
Yeah. The first quarter dynamics that we saw are likely to play themselves out not too dissimilarly in the second quarter because of the same factors that are affecting it. 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, and then, of course, we're anniversarying weaker base. 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 being 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 that separation work that's being done?
Yeah. The separation transaction is 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. 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. Actually, we have 135,000 employees. About 100 are in this project management office, which is really driving separation. 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. Their bonus is not based on how well we do the separation. It's on how well we deliver the business.
We are confident that the structure we've set up has allowed us to minimize the distraction of separation, there's no question. People are talking about separation, wondering how it affects them, et cetera. 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 first quarter with the weather, right? How do you guys think about driving the 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, we threw out a number of $500 million of savings we thought we could get. At the time, I thought there was more than that was even possible. We tracked ahead of it almost from the get-go, we've made some really good progress. 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. 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? When you're a company like us that is 50 years old, you accumulate a lot of legacy processes. When you get these people together in a room, which are all levels, we bring in this group of people and we say, "Check your level at the door. We don't care if you're 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 Gapathon." We found some really meaningful learnings that will allow us to re-engineer a lot of processes, where today we are too detailed, or we're doing things that we don't even know who the 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? That's a big unlock for us, we're using it to drive productivity today, then as we think forward to the separation.
Very helpful. I don't want to get bogged down in accounting. I don't want anyone to get a headache.
Yeah, exactly.
Let's talk about lease accounting. How did change and impact, and what we should be thinking about those items there.
We adopted the lease accounting with the first quarter. 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. 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 as a very complicated accounting model. Nonetheless, I think the information that is now contained on 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, 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 were asking this question of all the companies, just say one word, tariffs. What's the latest and greatest there that we should be thinking about from your perspective for your company?
The tariffs definitely represent a big uncertainty that's kind of overhanging everyone. We don't like tariffs any more than anyone else, we actually do feel like We've been asked a couple of times, "Well, what's your playbook on tariffs?" We actually have two elements of the playbook. One is to continue to reduce our dependence on China as sourcing. Today, in our last 10-K, we disclosed 21% as the amount sourced from China, that includes accessories and other things. The actual apparel number is closer to 16%. 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, 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. 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. We will do that through negotiations with vendors and other identified ways to reduce the associated AUC of the product. At the end of the day, we will be forced to pass that on to customers through price increases. We'll do that in a smart way. It's not gonna be in a blanket way. We'll do our best to mitigate any volume impacts from increased pricing. 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, one, the Janie and Jack acquisition, then second, the launch of Hill City. Just give us some perspective on those. What are you looking at those strategically at for? Just give us some perspective.
They're both very interesting brands for very different reasons. We bought Janie and Jack quite opportunistically in the Gymboree liquidation. We weren't out looking for a kid baby brand, but lo and behold, Janie and Jack is actually a very good fit in our portfolio and at a price that we feel very good about. 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. 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 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. 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.
This is a lucrative space. It's an underserved space. We were able to launch quite quickly by leveraging a lot of the talent and capability that's within the Athleta organization. It's early days. It's doing fine. We'll see. We didn't expect it to be a $3 billion brand. Time will tell. We are really fortunate to be able to use this as an experiment and a learning vehicle. 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. Thanks, Teri. Really appreciate your participation. Thanks everybody for listening. Thank you.
Thanks, Randal.