Good afternoon, everyone. Welcome to Gap Inc. 2nd quarter 2015 earnings conference call. Before we begin, I'd like to remind you that the information made available on this webcast and conference call contains forward looking statements. For information on factors that could cause our actual results to differ materially from the forward looking statements as well as reconciliations or descriptions of measures we are required to compare to GAAP Financial Measures, please refer to today's earnings press release as well as our most recent annual report on Form 10 ks and our subsequent filings with the SEC, all of which are available on gapinc.com.
These forward looking statements are based on information as of August 20, 20 15, and we assume no obligation to publicly update or revise our forward looking statements. Joining us on the call today are CEO, Art Peck and Executive Vice President and CFO, Sabrina Simmons. Sabrina will be using slides to supplement her remarks, which you can view by going to the Investor Relations section at gapinc.com. With that, I'd like to turn the call over to Art.
Thanks, Jack. Pleased to be here today, pleased to be talking to you. Sabrina will take you through the first half and Q2. I'm really going to focus on the back half of the year and as we get into 2016. We are making progress on the journey that I've articulated to you in the work that's going on at Gap and at Banana Republic.
Let me start with Old Navy and then I'll talk a bit about the other brands as well. Pleased with Old Navy's performance. I see strength as I look into the back half. Obviously, we look at all the products as we go through the months and very pleased with where the women's business is as well as the other businesses that surround women's at the end of the day. Active has been a strength that they continue to build.
We now have an active expression that sits across the entire family. As I look out into September October, I think the fall product for Old Navy is going to be right in the sweet spot of what's on brand, on trend and a great value proposition. And I'm excited about what they can do for this company in the back half. Old Navy's consistency continues to be a thing of beauty. It sits on a platform of product process that they have built over the last couple of years and now are pretty relentlessly executing season after season.
It's those same product processes that we are pretty far along now in installing in Gap and Banana Republic. And as I've said before Old Navy remains our proof point for building product, executing trend, delivering on brand, on quality, on fit product consistently for the rest of the company. We see a very long runway of growth for Old Navy. They've gained roughly $1,000,000,000 of market share over the course of the last 3 years. They are continuing to build out their responsive supply chain capabilities, platforming fabric, becoming faster and faster in responding to consumer needs.
And I'm very pleased with the progress that Stefan and the team have made and the outlook that we see for the back half and 2016. Let me then turn to GAAP. The steps that I have laid out with Jeff as we've focused on getting the business back on track. First of all, obviously started with recruiting the team around Jeff And that is now largely done. Since I spoke to you last, Steven Sayer has joined as Head of Global Merchandising.
Steven is a talent and we're very pleased to have him. That team has been focused obviously on spring of 2016 and I'm confident that they have been doing the right work to get the business back on track as we get into next year. 3 weeks ago, I was in New York with the entire team. We did a full style leather on figure review of the adult assortment. I saw terrific progress in terms of re centering on what the brand equities are on fit, on quality, on femininity, on optimism.
They're hallmarks of what Gap brand is all about. I'm not going to stand up at the plate and call which fence we're going to hit it over. That's not who I am. But I am confident that Gap will make significant progress in spring and very pleased with what I've seen in the women's assortment and the turnaround in the women's assortment. While being focused on getting the spring women's assortment back on track, which the team has been spending most of their energy on and they've now obviously turned to summer, At the same time, they've been rebuilding the product processes inside the business.
And I've referred to this before using Old Navy as the template, built more responsive capabilities, platformed much of the fabric. And I'm very encouraged by what these capabilities will be able to deliver for us as we get into 2016. For the first time, we will be going to in season open in some of our key product programs and therefore able to get back in after we read the business in season with significant quantities of units. This is obviously an important capability for us. We're building this across the entire company and it's great to see Jeff and the team make progress like this as quickly as they have.
Let me for a moment just address the strategic actions that we announced we were going to be taking when we last spoke with you. I'm really pleased with the progress that Jeff and the team have made. We will have stores being closed over the course of this year. But the work on restructuring the business on working with our landlords to make sure that this was an orderly process has largely been done. And what that does is it gives the team the ability to really now focus on the business going forward.
Let me turn for just a moment Banana Republic. It's not a place where I've spent a lot of time talking to you in our last couple of calls. So I want to spend a moment there and give you my perspective as to what we're looking at in the back half and as we get into 2016. I'm really confident with the design point of view that we have in the business. I feel like the team underneath Marissa is really centered on the aesthetic of the brand really in the sweet spot of what Banana is and should be.
And I'm confident that we have a significant opportunity as we get into the latter half of this year and next year to really drive the business through merchandising as well. I feel like we can support our big ideas and there are several in the pipeline and buy the line in a way that can buy the business. I'm really excited to see what this brand can do as we get to the end of the year and into 2016. Let me turn last to China. And obviously, over the last even couple of weeks, there's been a lot of news coming out of China and it's an important area of long term growth for us.
I was in China just a few weeks ago, spent a week with the team in stores in several cities. And quite simply, I and we are continuing to be very bullish on our opportunity in China. We'll process the currency devaluation and the team is working on that right now. I don't see that really giving us any significant headwinds as we think about the continued growth of the China business. We continue to look at a very robust store pipeline there as well.
Our outlet business continues to grow in China. And so really as far as I'm concerned, no change in strategy, no change in direction, no change in intensity as we continue to look at China as a significant long term growth opportunity for the company. So before I close, I would just like to address the fact that there's a lot of noise really out there right now around the apparel sector. And just so you know my perspective, I shut it out, because from where I sit across all of our businesses, our job is to deliver regardless of the noise that's out there today. And what I see is, I see a consumer who has confidence.
I see dollars being spent. And I see an opportunity for us to continue to get more than our fair share as I look forward. And I am very optimistic given the work that's going on inside of Gap and Banana and the continued consistency that I see in Old Navy, very optimistic about what I see in front of us. Now let me turn it over to Sabrina.
Thank you, Art. Good afternoon, everyone. As anticipated, our results were impacted by foreign exchange, West Coast port issues and our previously announced strategic actions primarily related to Gap brand. Given the number of unique factors impacting financial results, I'm going to zoom out and quickly speak to our first half results on a normalized basis. Beginning with foreign exchange.
In the first half, foreign exchange negatively impacted earnings per share by 0.06p With the accelerated weakening of the yen and Canadian dollar, the FX impact of 0.04p to Q2 was larger than Q1. With regard to the West Coast port situation, the first half impact of the port delays was about $0.13 in line with our original estimate, but slightly weighted toward Q2. And finally, the charges associated with our strategic actions, which were publicly disclosed in mid June, totaled about $95,000,000 in the first half or about $0.14 As a reminder, these charges primarily include costs associated with lease buyouts, asset impairments and employee related costs. Excluding these items, our underlying business delivered adjusted earnings per share growth of 12% over last year. We're pleased that despite our product challenges at Gap and Banana Republic, we were able to use all of our levers to achieve this respectable underlying earnings per share growth in the first half.
Turning now to the 2nd quarter performance. On a constant currency basis, net sales were about flat. Foreign exchange negatively impacted our reported net sales by about $100,000,000 in the second quarter. As reported, net sales were $3,900,000,000 down 2% versus last year. Total sales and comps by division are in our press release.
Moving to gross margin. 2nd quarter gross margin was down 200 basis points to 37.4 percent. Rent and occupancy deleveraged 40 basis points. Merchandise margin deleveraged 160 basis points and was negatively impacted by both the ports and foreign exchange. With regard to SG and A, we continue to manage expenses tightly.
2nd quarter total operating expenses were $1,100,000,000 including about $70,000,000 of charges associated with our strategic actions and about a $30,000,000 benefit from foreign exchange. Excluding these items and last year's gain on sale, adjusted SG and A dollars were about flat year over year. Marketing expenses were down $11,000,000 to $131,000,000 Turning to earnings. Excluding the negative impact from strategic actions, which was about 0 point 12 dollars earnings per share were $0.64 or $0.52 on a reported basis. Regarding the balance sheet and cash flow, inventory dollars per store were up 1% at the end of the second quarter, in line with our guidance.
Year to date, free cash flow was an inflow of $341,000,000 Consistent with our opportunistic approach, we're pleased to have spent over $600,000,000 on share repurchases year to date. In the Q2 alone, we spent over $375,000,000 repurchasing 10,000,000 shares. Including our dividend, year to date shareholder distributions totaled about $800,000,000 We ended the quarter with a share count of $410,000,000 and a cash balance of $1,000,000,000 Regarding capital expenditures and store count, year to date capital expenditures were about $300,000,000 On a net basis, we opened 29 company operated stores year to date, including 40 Gap brand closures. We ended the quarter with 3,309 stores. And now I'd like to share our outlook for the rest of the year.
Given that our first half performance was within the scenarios embedded in our initial full year outlook, we are reaffirming our full year earnings per share guidance range of $2.75 to $2.80 This range excludes the charges associated with our strategic actions. With regard to those actions, we now estimate the charges to be around $130,000,000 to $140,000,000 Excluding the costs associated with our strategic actions, we continue to expect operating margins to be down about a point versus 2014 driven by the negative impact from foreign exchange, the first half port issues and last year's gain on sale. While we continue to pursue our growth initiatives in Asia and domestically with Athleta, given our Gap brand closures, we now anticipate store count and square footage to be about flat for the year. Regarding inventory, we expect Q3 inventory to be down slightly. For the full year, all other guidance metrics remain substantially unchanged.
In closing, while the business experienced challenges in the first half, we are pleased to have delivered underlying EPS growth of 12% and to have distributed about $800,000,000 to shareholders, underscoring our commitment to returning excess cash. As we enter the Q3, we'll continue to focus on levers that we can control and advance the initiatives that will drive future improvements. Thank you. And now I'll turn it back over to Jack.
That concludes our prepared remarks. We will now open the call up to questions. We'd appreciate limiting your questions to 1 per person.
Thank you. And we will go first to Anna Andreeva with Oppenheimer. Great. Thanks so much and thanks for taking our question. A question on Old Navy.
This division has demonstrated for some time now some very strong top line and bottom line momentum. As we approach the tougher comparisons in the Q4 especially, can you maybe talk about the trade off between your AUR and transactions to drive positive comps? And specifically, what categories are you particularly excited for holiday? Thanks so much.
Thanks, Anna, and thanks for the question. I know that we're looking at those tougher comps. Again, I would point out that we've got 3 years under our belt with the business and that's a function of how we're bringing product to market as we pointed out several times. If I look across the business, the women's business is performing. I've now seen product looking out through the rest of the year.
Really excited about the where we are from a trend standpoint across a number of categories. And that's probably what's most important to me is that the strength of the business is diversified. It's not singular. And then if you add on top of that some new categories that really have not been powering the business until we've built them out over the last couple of seasons like active, I feel really good about what Old Navy has as ammunition to deliver the back half.
Yes. And the only thing I'll add with regard to sort of our levers is Old Navy has done a nice job for the better part of the year in participating in a promotional environment while still delivering high quality margins. And we intend to continue that into the back half. So AUR will be an important lever as we continue to manage inventory responsibly and prudently there.
And we will go next to Matthew Boss with JPMorgan.
Hi, good afternoon. So as we think about SG and A, you've trimmed roughly $150,000,000 of expenses from the base over the past 2 years. My question, what kind of flexibility remains if sales were to remain constrained? And then on the balance sheet, what's the adjusted leverage ratio or debt to EBITDA you're comfortable with going forward and just the minimum cash balance to fund the business?
Great questions. So starting with expenses, I mean, we like to think, Matthew, that our work is never over. There's always opportunities to work more productively and efficiently in the business. As a reminder, a large part of our expense base is variable to sales, whether it's per unit because of DC costs or whether it's related and variable to store costs, a large piece is variable. So of course, when sales are increasing, we would expect nominal dollars to increase.
But if they are not increasing, then we do our very best as we've been demonstrating to be responsible and to hold all of our other discretionary and overhead items very tightly combined with the natural benefit we get from the variable piece. So that's that piece. With regard to the balance sheet, let me see if I can remember your questions. I know one was on cash. And so we still target roughly between $1,000,000,000 $1,200,000,000 as our cash on balance sheet target.
And we ended with $1,000,000,000 So we're very comfortable with where we ended the quarter. And then with regard to our ratios, I would say broadly speaking, we like being an investment grade credit. It gives us a lot of flexibility in our business and we have fought hard for those. So we try to remain consistent in our ratios with the agency's guidelines on what constitutes investment grade. Guidelines on what constitutes investment grade.
Okay, great. That was really helpful. Thanks. And we will go next
to Simeon Siegel with Nomura Securities. Thanks. Good afternoon, guys.
Just a quick clarification question for Sabrina, if I can.
So the first what's
the first half EPS that
the $2.75 to $2.80 is
based off of? Is that the $1.42 underlying? And then just assuming constant share count, does that just imply the back half EPS is around $133,000,000 to $138,000,000
So the $2.75 to $2.80 guidance assumes our reported EPS excluding the GAAP, mostly GAAP charges that we've described since June 15. The foreign exchange is embedded and the port is embedded. So it includes everything except for those strategic action charges as outlined on June 15. Is that helpful, Simeon? So
I guess is that the $142,000,000 or is it a piece of the $142,000,000 underlying number?
The $142,000,000 excludes all of the components. So the only so again, our the 2.7 $5 would include the foreign exchange, which is the $0.06 and it would include the port of $0.13 So it wouldn't be the $1.42 would be adjusted for those $0.19
Perfect. Great. Thanks. Sure.
And
we will go next to Betty Chen with Mizuho Securities.
Thank you. Good afternoon.
I was wondering Art if you can talk a little bit more about the in season open program that you mentioned earlier. It sounds like an exciting opportunity for the team to kind of get a chance to read and react and also be able to chase into better selling items. What percentage of the collection will be part of that program? And is it in all brands that you mentioned? And so any additional color would be helpful.
Thanks.
Yes. And I'm not going to
give you specific numbers here because we're actually still a ways out. And we're obviously trying to build this as quickly as we can and use it as quickly as we can. And the numbers and what I referred to here was that GAAP would be for the really the first time in a significant way using this capability. The way we're thinking about it, that is against key programs. This is a business that's where we manage it around the top 30 mentality of our key styles.
And so we're using it in key programs. And we're going to roll it quickly and it's based upon a combination of obviously reading the business, having open to buy, having platform fabric at vendors who are capable on an integrated basis of cutting, washing, dyeing, etcetera and proximate sourcing. And so there'll be more to say about this, but it does involve putting products in our stores, testing and then responding in season and I'm really excited about it.
And Art does that go live for the spring season or more so the second half of twenty sixteen?
In spring, we'll be going in with the capability applied in a couple of places in the business.
Great. Thank you so much. Best of luck. Yes.
And we will go next to Dorothy Lachner with Topeka Capital Markets.
Thanks and good afternoon everyone. Wondered on the Gap, if you could talk a bit about the bottoms business. That's certainly been a mainstay. And we are talking about somewhat of a resurgence in denim overall in the industry in the back half of the year. And just wondered if you could talk a little bit about how you might benefit from that even with the rest of the assortment not necessarily where you want it to be at this point?
Yes. I've said it before and I'll just reiterate, we are pretty confident that the denim cycle has hit bottom and has been coming back over the last several months. You also know from where I sit and I've said it before, I'm strong proponent of really buying lean as we go into season and obviously then as we build responsive capabilities and then getting the upside on the AUR. So what I'm seeing in denim right now and it's for Gap in particular that's largely the bottoms business, especially past summer. We're seeing trend being indigo, trend being destructed, ten being patch and repair and then some variation in leg shape and rise.
And we're buying responsibly into those in the back half and then in spring 2016 as well. The other thing that I'm really, really feeling good about to be quite honest is our fit. Fit should be an asset for this company and we have had fit challenges and consistency challenges in bottoms and gap and it's something that the team has been very resolutely focused on and I'm seeing some significant progress there. It's probably more of a spring where I'm comfortable saying it's more of a spring issue that it really hits, but it's definitely on the team's mind.
Great. Thank you.
And we will go next to Kimberly Greenberger with Morgan Stanley.
Great. Thank you so much. Art, I wanted to ask
you a little bit about Banana. The some of the new designs hit in the April, May timeframe. We haven't really seen the customer respond yet to that product. You've mentioned though in your prepared remarks that you're confident in the design and the opportunity to drive the merchandising in the second half of twenty fifteen and twenty sixteen. So I'm wondering if you can help us with the changes or adjustments that are being made either within design or to the merchandising process that you think will lead to that improved trajectory?
Thanks so much.
Yes. And I've we had a
new team come in led by Andy and several new members underneath the team, including supplementing the design team underneath Marissa and some changes there. And we have a team now that I am very confident basically complete. The seats are full. And the first thing they did was dig into back half product and look and see where they are right now. And there are some styles in the assortment as you can imagine that we wish were better, but they really have their arms around the assortment architecture and how we're buying the business really into Q4 and then in the spring of 2016.
And I'm distorting my energy as you can imagine towards looking at the product that's in the pipeline. And so I'm now seeing each seasonal collection as it's in concept and then in adoption. And I'm pleased and I know Andy is pleased and the team are pleased with how it's coming together. When I refer to the merchandising opportunity, obviously it's designing a collection that's commercial and then it's buying it with a point of view and putting your dollars behind the big ideas are going to drive the business. And we've been bought more flat over the last several seasons versus really distorting towards a point of view and that's something else that Andy is really focused on as we get later in the year and into 2016.
And we will go next to Susan Anderson with FBR and Company.
Hi, good evening. Thanks for taking my question. On the product front, just one quick question on that. Should we think about maybe some quality being added back into the product for spring next year too? And then on the store closures, how should we think about the cadence going forward?
And if you have any thoughts maybe around the sales retention that you guys think you can get maybe either to online or other stores out of those? Thank you.
Yes. On quality, the answer is it's been on everybody's list. And what I don't want to do is say quality that therefore comes at a massive cost because those two things don't necessarily go hand in hand. We are focused on restoring quality in key places of the business where it is relevant and perceptible and differentiated for the customer. And so that's been a particular focus inside of Banana and a particular focus inside of Gap.
And it doesn't always come for free, but it doesn't always come with a cost either. And so you could easily choose a yarn and a sweater that's actually more expensive because of the hand feel that it delivers, but it's a yarn that doesn't meet our pilling standards and therefore for the customer it's a lower quality experience. And so this is something that's on my radar. I've mentioned it before. It's on the radar of the teams for both of those brands as well as Old Navy.
The customer has a quality expectation that's an opportunity for us. And so should expect to see some of that in the back half of the year, but it's been a very intentional focus of design, merchandising, production and sourcing as we get into the beginning of next year. On the store cadence, why don't I turn that over to Sabrina and she can talk a little bit and I can jump in if I need to.
Sure. So on the store closures, we're pretty much on track with where we thought we'd be. So we closed about 30 Gap stores in the first half. And our best estimate is we're still on target to close about 140 of the 175 North America specialty stores we talked about on June 15. So everything pretty much is still on track there, but we'll be updating you every quarter.
With regard to the sales retention, we talked about $300,000,000 of sales being associated with the store closures in total. And we're pretty transparent that historically, we haven't seen a lot of sales transfer within Gap Brand. Now that said, we made a very large concerted effort this time to really, really go after the customer with some email pieces, direct mail pieces, signage in stores mail pieces, signage in stores to try and recapture to the next closest Gap store as well as online. And in addition to that, many of these stores were in markets where there was an Old Navy nearby. And so the Old Navy team also focused and will continue to focus on recapturing some of the sales that are coming from the closed stores.
Great. That's helpful. Thanks.
And we will go next to Lorraine Hutchinson with Bank of America.
Thank you. Good afternoon. Sabrina, could you talk about how you're thinking about currency and the impact on next year given the recent moves in rates?
Sure. So at a high level, as a reminder, for our legal entities that do business outside of the United States and the biggest businesses I'll focus on again for us are Japan and Canada because those 2 together are really our biggest currency exposure because we have about $2,000,000,000 worth of sales between those two countries. Unfortunately, those currencies have continued to depreciate. So we hedge, of course, those operations are in local currency and they buy the vast majority of their cost of goods in U. S.
Dollars. So they're exposed to the depreciation of their currency. And we hedge for them 12 to 18 months forward to give, A, our merchants and our team certainty around what the cost of sales is, but also obviously it eases the impact of the depreciation of the currencies. Now it doesn't prevent the depreciation of the currencies ultimately hitting us. It only delays it.
So with the continuation of the depreciation of yen and CAD in particular, we're probably going to expect to see continuing headwinds into 2016. Now currencies are really volatile. We'll see when we get there and we'll talk more about that obviously on our Q4 call when we finish doing most of our hedging and we have our budgets done. But I would say from where we sit today given the way the currencies have moved, we're going to probably continue to feel headwinds maybe around the same magnitude, hopefully not, but maybe around the same magnitude as we have this year. Thank you.
And we will go next to Oliver Chen with Cowen and Company.
Hi, thank you. Sabrina, I'm just curious about your views on the merchandise margins for the back half in terms of the puts and takes. And I know that you're looking to see a better improvement for Gap division not until next spring. And Art, just briefly, what about your bigger picture view for Banana Republic in terms of the market position and the customer profile about where it could go versus where it is now? Thank you.
Yes.
So I'll start with merch margins, Oliver. And we don't give hard guidance on merch margins. But to be helpful directionally, what we are looking to do, obviously, is to continue to manage our inventory very tightly. And you heard me say coming off of a Q2 where we met our guidance and we were only up 1%, we're looking to come down now in Q3 slightly. So we're just we just keep ratcheting the inventory to get tighter and tighter.
And we feel that gives us a better probability of getting our average unit retail up and our margins up. We'll see where they actualize. We'll see customer response. I think our shot probably better in Q4 given what Art laid out with regard to Banana Republic and Gap modestly changing their assortments for holiday, not so much for fall. So that's what I'd give you to try to be helpful.
And then I'll just go I don't want to spend a lot of time on this Oliver and happy to talk about this as well longer. I guess I have a model in my brain as I think about this business, which is number 1, obviously the competition is extraordinarily fragmented, which to me is a blessing, because it means that everybody there are many, many, many share gain opportunities for us. And then I think about the business in terms of pricing bands, across categories and the pricing bands obviously range from extreme value to luxury and everything in between. If I look at the opportunity for Banana positioned where it is, when it's executing well, there's a very large opportunity for us there. And so I'm pretty excited about the growth there as we get the business back on track and especially as we're building the product platforms underneath Banana to be more responsive and more quick and more on trend.
So it's a place where we don't probably talk about it as much as we do certainly with Gap and the situation there and then obviously with the strength of Old Navy. But to me it is a quiet powerful growth asset for this company.
Thank you. Best regards.
And we will go next to Dana Telsey with Telsey Advisory Group.
Good afternoon, everyone. Can you talk a little bit about marketing? Marketing was down. What's the plan for holiday given that the new product won't be fully up and running yet? And how do you see it both stores and what you're doing with omni channel?
Thank you.
Thanks Dana.
I'll start Dana with Q2 and marketing was down driven primarily by Banana and then Piperline and a little bit of Gap. For Q3, we'll probably expect it to be down again. I mean you guys might remember we had a fall campaign for Gap last year, which we're not anniversarying. So we're probably going to be down some because of that alone and also the absence of Piper Lime. I mean, no other dramatic changes and we might even invest a little more in other brands like Old Navy.
And I would say it's probably a little early to talk about Holiday because we haven't finished those plans. But I don't know Art if you want to add anything.
No. I mean I'll give a somewhat trite answer honestly. But nonetheless I think one that I feel pretty strongly about which is the best marketing is good product. And if I look at Gap as an example, we drove a strong business back a couple of years ago in spring of 2012 with modest marketing, but exceptional product. And so what I can say is that as we feel better about the product, that will help us think about the marketing that we're willing to put behind it.
But I do believe that your marketing should lag good product and that a lot of what will drive a bounce in the business is good product in the stores which you then put some marketing behind in maybe the next period. So we're managing it very carefully. And again, as Sabrina said, too soon to talk about what we're going to do in Q4. It's not really there yet.
Thank you.
Yes.
And we will go next to Adrienne Yih with Wolfe Research.
Good afternoon. My question is on inventory. If you can help us out with kind of inventory by division. If I recall last year, when Old Navy was performing exceptionally well, there might have been a point in time when you wish that you had more inventory. So I was wondering if as you go up and anniversary those compares that you might give it a little bit more fuel, so to speak?
Thank you. Yes. Directionally, Adrienne, I would tell you for sure GAAP is going to be the tightest, followed closely by Banana. We're going to because of their performance year to date, and because of we have the most confidence behind Old Navy, we're going to be very tight with Gap and Banana. And then to your point, Old Navy does still manage for their sales level tightly.
They're going to have more inventory for sure to feed their momentum. But I think they're on to something really good and we're all holding hands on. We'd like to see a little improvement in turn as we go forward. So I think across the board tight, but directionally, OMA is definitely going to be inventory better than GAAP or BR. Great.
Thank you very much. Good luck.
And we will go next to Brian Tunic with Royal Bank of Canada.
Hi. Thanks. Good afternoon. I guess question, maybe talk Sabrina about the rod leverage point maybe a little given the store closing announcements? I know you've said that the China and international openings have raised that leverage point.
But does this now enable the business to get rod leverage at a lower point or at least maybe into next year? And then maybe our I know we're lapping last year's GAAP slowdown in the product side. How should we think about the categories you'd expect to turn over time to the start in women's tops, you're seeing a little better trend in denim. Maybe just talk about in the next couple of months here even what we should be seeing at the Gap division versus last year?
Yes, starting with Rod, you're correct, Brian. We said that most recently, it will probably take a low to mid single positive comp to leverage Rod for the reasons you laid out, more of a mix toward international and some higher rents. And with regard to the impact of the store closures on Rod, I would say it's not going to be that meaningful. And the reason is, you'll recall that we're the stores we're closing are mostly in the lower quality centers. And in those centers, we actually had pretty favorable rents.
So when we take those out of the portfolio, it doesn't really help your rod leverage much because as a percent to rent, that wasn't the issue with those stores. It was more brand positioning with those stores.
And then if you just go to categories and I'll be consistent here and not call significant change in the business in the back half even though the team has been able to make some incremental changes as they looked at both fall and holiday. So if you look at GAAP, where do I expect bounce as we're getting the aesthetic on trend quality etcetera on track? You can just look at the public data and see where we've given up market share. Knits is a big category in women's where we gave up market share. It is a knit cycle right now.
It is an opportunity for us to get our share and more than our fair share. Denim is coming back which is a place that powers the brand and I believe we have really good product development in the pipeline. And those are 2 big categories for the brand. It should always be brand drivers for Gap. And so I'll just stop there at the moment, but that's team's obviously been focused across the entire assortment.
But to be able to ride the bounce in denim and then reclaim and more so our fair share in knits is a big opportunity for us.
And Amber, we've got time for one more question.
Yes. And we will go to Richard Jaffe with Stifel.
Thanks very much. Two questions. Quickly, if you could just clarify the strategic charge in 1Q, I know it's $71,000,000 in 2Q. Was there any
in 1Q? Am I mistaken in thinking there was?
No, you're right. You're right, Richard. It's a good call out. So just before as we were building into the public announcement, we started taking some small actions in the Q1 related mostly to some inventory and related to the store closures. And when we gave our initial estimate on 615, it included a little bit of that action we had already taken in Q1 building into the announcement.
So consistent with that, the number we just gave out for the first half has a little bit of spend in Q1 as once it was announced, we accumulated the total charges.
So the $71,000,000 doesn't include the amount in 1Q, but the $140,000,000 does?
Correct.
Great. And just a quick
kind word on the franchise operation internationally?
Well, franchise operation continues
to be a business that we believe it really strongly. Obviously, also some foreign exchange headwinds there, which we don't call out separately. But we're bullish on it. And now we're really just starting to put Old Navy into the mix. And so far the read on Old Navy in the Middle East and in the Philippines has been very positive for us.
I don't want to go into a lot more detail right now, but it's a business that we are long term committed to and getting Old Navy in the mix is pretty powerful for us.
Great. I'd like to thank sorry, I'd like to thank everyone for joining us on the call today. As a reminder, the press release, which is available on GAAPinc.com, contains a full recap of our Q2 results as well as the forward looking guidance included in our prepared remarks. As always, the Investor Relations team will be available after the call for further questions. Thank you all.
That concludes today's conference. Thank you everyone for your participation.