I would now like to introduce your host, Katrina O'Connell, Vice President of Investor Relations.
Good afternoon, everyone. Welcome to Gap Inc.'s fourth quarter 2014 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're required to reconcile to GAAP financial measures, please refer to today's earnings press release, as well as our most recent annual report on Form 10-K 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 February 26, 2015, and we assume no obligation to publicly update or revise our forward-looking statements.
I also want to mention that Sabrina will be using slides to supplement her remarks, which you can view by going to the investor relations section at gapinc.com. Joining us on the call today are CEO Art Peck and Executive Vice President and CFO Sabrina Simmons. Now I'd like to turn the call over to Sabrina.
Thank you, Katrina. Good afternoon, everyone. Let me start with some highlights for the year, and then I'll go through Q4 results before turning to the outlook for 2015. For the full year, EPS grew about 10%, excluding the estimated year-over-year impact from foreign exchange. On a reported basis, our earnings per share for the full year grew 5%. Our largest brand, Old Navy, delivered positive comps in each quarter and finished the year with a strong 11 comp in Q4. We achieved our goal of leveraging expenses. At 25.6% of sales, our SG&A rate was the lowest since 2005. We generated free cash flow of $1.4 billion and distributed about $1.6 billion to shareholders through share repurchases and dividends. Moving to the fourth quarter and full year financial results.
Regarding earnings, there's been quite a bit of focus on the recent strengthening of the U.S. dollar and its impact to 2015 earnings, which I'll address, of course, in the outlook. It's important to note that we've already absorbed a great deal of foreign exchange headwind in 2014. Full year net earnings were $1.26 billion, and earnings per share were $2.87. This includes about a $0.14 unfavorable impact from foreign exchange. The FX impact was most pronounced in the fourth quarter. Excluding the estimated year-over-year impact from foreign exchange, Q4 earnings per share grew about 20% versus last year. On a reported basis, net income was $319 million, and earnings per share increased 10% to $0.75 per share. Turning to sales. Sales for the fourth quarter were $4.7 billion and increased 5% on a constant currency basis. Comp sales were up 2%.
For the full year, net sales were up 2% to $16.4 billion and up 3% on a constant currency basis, driven by Old Navy strength. Comparable sales were flat for the year. Moving to gross margin. Fourth quarter gross profit increased by $65 million to $1.7 billion, and gross margin expanded by 40 basis points to 35.2%. Merchandise margins were up 60 basis points for the quarter, and rent and occupancy deleveraged 20 basis points. For the full year, gross profit was $6.3 billion, and gross margin was down 70 basis points to 38.3%. At the beginning of 2014, we stated that foreign exchange would likely pressure our merchandise margins. For the year, merchandise margins were down 40 basis points, driven by this FX impact, as well as disappointing performance at Gap brand. As anticipated, rent and occupancy deleveraged by 30 basis points. Regarding SG&A.
For the fourth quarter, total operating expenses were $1.1 billion, with marketing expenses at $178 million, slightly below last year. Total operating expenses for the year were $4.2 billion and leveraged 10 basis points despite moving $160 million of credit card income out of SG&A and into merchandise margin. Marketing expenses for the year were $639 million, about flat to last year. Regarding stores and capital expenditures, we opened 116 new company-operated stores in 2014 net of closures. In line with our strategy, international store growth was focused primarily in Asia. In North America, store growth was focused on our outlet channel and Athleta. Not surprisingly, closures were focused on Gap specialty North America. Our square footage grew by 2.4%, in line with our guidance. Store counts and square footage by division are in our press release.
Regarding the balance sheet and cash flow, as we stated would be the case, we improved inventory levels throughout the year. Inventory dollars per store were down 5.5% at the end of the fourth quarter. This was better than our previous guidance, driven by foreign exchange favorability and stronger than expected sell-through at Old Navy. We ended the year with about $1.5 billion in cash after having distributed about $1.6 billion to shareholders. Ending share count was 421 million shares. Now I'd like to share our outlook for 2015. Regarding earnings per share, on a reported basis, we expect earnings per share to be in the range of $2.75-$2.80.
Included in this guidance is an estimated unfavorable impact from foreign exchange at current spot rates of about $0.16, an unfavorable impact of about $0.13 due to the West Coast port situation, and an expectation for a slower turnaround at Gap brand. Excluding the impacts of foreign exchange, the port issues, and last year's gain on sale, our underlying expected EPS growth rate for 2015 would be about 12 percentage points higher or about 9% EPS growth at its midpoint. Now let me address the port issue. While we've been managing the slowdown at the ports for some time, it's the additional weekend closures in February and the resulting additional backlog that are driving the expected negative impact to earnings. In simple terms, the first quarter is impacted by having fewer units available for sale.
It's important to note that this is particularly impactful to Old Navy, given the importance of the Easter holiday to Old Navy's business. Additionally, the second quarter is impacted by late units arriving in Q2 and potentially being sold at lower margins, given that fall flows come in shortly thereafter. Regarding our inventory guidance, excluding the impact from the port situation, we would have expected inventory dollars per store to be slightly down at the end of the first quarter. Given the fluidity of the situation, we'll provide an update on inventory later in the quarter. Moving on to the impact of foreign exchange to the year ahead. At current spot rates, we estimate that foreign exchange will negatively impact our reported EPS growth rate by about six percentage points. This equates to about $0.16 or over $100 million of pre-tax earnings.
While comp is reported on a constant currency basis, the remainder of our reported performance is subject to currency fluctuations. As a reminder, our largest foreign subsidiaries are in Canada and Japan, with combined sales in these two countries of over $2 billion. Both the Japanese yen and the Canadian dollar have depreciated by about 30% over the past two years. With the continuing depreciation of these and other currencies against the dollar, our reported results have been and are expected to be negatively impacted. There are two primary impacts of foreign exchange. The first is translation, and the second impact is the economic impact to our merchandise margins. We hedge the majority of our inventory purchases for our foreign subsidiaries 12 to 18 months in advance. Effectively, this delays the impact of depreciating foreign currencies on most of our cost of goods.
However, as the old hedge rates lapse and new, less favorable hedge rates come on, the cost of goods in local currencies will increase. In addition, unhedged inventory purchases will be subject to foreign exchange movements. Moving to expenses and operating margins. We have a strong track record of managing expenses, and we intend to continue that. However, it's unlikely we'll leverage expenses in 2015. As a reminder, we're lapping the $39 million gain on sale, as well as absorbing the increase to our minimum hourly wage that we announced last year. Given the negative impact from foreign exchange, the port issues, and last year's gain on sale, we expect operating margins to be down about a point to 2014 on a reported basis. However, excluding these three factors, we expect that operating margin on an underlying basis would modestly expand. Here are some other guidance metrics.
We expect to add 115 net new stores, with our year-end store base in China growing to over 150 stores and Athleta store base growing to 120 total stores. Square footage is expected to increase about 2.5%. We expect capital expenditures to be about $800 million, with the increased focus on omni-channel and supply chain capabilities. We expect depreciation and amortization to be about $525 million, and we expect our full-year effective tax rate to be about 38%. Finally, we remain very committed to our principle of returning excess cash to shareholders. Underscoring that commitment, we are pleased to have announced a new $1 billion share repurchase authorization and our intent to again increase the dividend to $0.92 per share. As we enter 2015, we remain focused on using all of our levers to further drive value for our shareholders. Thank you, and now I will turn it over to Art.
Thank you, Sabrina, and good afternoon. It is really a pleasure to be here addressing all of you. Before I go into anything concerning the business and looking forward, I would be remiss not to thank Glenn for everything that he has done for the company. His tireless effort over the last eight years. What he brought the company in terms of vision, strategy, discipline, and most importantly, results. I have to thank him as well for everything he did as we worked shoulder to shoulder over the last few months during this transition time. We, as a team, feel that he was incredibly helpful to all of us in effecting a smooth transition, in sharing his perspective on what we need to do going forward, allowing the team to get settled in to hit the ground running in 2015.
Again, I need to thank him on behalf of myself and the team for everything that he has done. I have been in the job now for officially about three weeks. I am very bullish on the future of this company. We have great brands with tremendous potential. I am extremely pleased with the team that is now in place and equally pleased with the consistent sense of urgency that every member of my team has in making the changes that we need to make to compete successfully and consistently. Product is critical for us, and consistent product season after season appropriate to our brands is a non-negotiable. As I look forward, I first want to talk about where we are today. Let me spend a moment and talk about the guidance that Sabrina gave to you.
To be clear, I fully believe in the economic model that we have articulated and that we have been executing over the last several years. That said, there are three issues that are going to affect our performance in 2015. The two are macro issues with foreign exchange and the port situation, and the third is the performance of Gap brand. I want to double click for a moment on Gap. None of us are satisfied with the performance that we are seeing at Gap. I made a very quick change with senior leadership there. I did this because we were not seeing the performance improvement in the business that we needed to see. Specifically, I was not seeing the women's product back on track the way it needed to be for the brand to perform to its potential.
Jeff and I are together focused on what we need to do in order to get the brand back on track. It starts with righting the women's business. There's an aesthetic issue which we're working on today with urgency. We're pleased to see that the denim business seems to be showing signs of life. Gap as a brand is much more than denim, and we need to have the women's business hitting on all cylinders in order for the business to deliver the performance that we expect. 2015 is largely bought really through fall right now. Jeff and the team are focused on making product changes that they can make, but those will be modest and incremental until we get to late in the year. Holiday is under significant scrutiny now. I have looked at it. Jeff has looked at it.
The team is focused on it to make as much improvement as we can before we buy the product. Let me quickly refresh your memory. In early 2011, I sat in the same seat that Jeff is sitting in right now at Gap brand. I know from my experience, I'm sharing this with Jeff, that we can get the brand back on track quickly with a relentless focus on product. When Jeff got into his role, he moved quickly to make some changes on his team. The obvious hole has been the leader of design. I'm very pleased to announce today that Jeff has hired Wendi Goldman, who will be rejoining our company in a new role as head of design and product development for the brand.
I've gotten to know Wendi over the course of the last few months. I feel very confident that she will be a strong creative leader and a significant addition to the team. She knows our company from eight years here early in her career. More importantly, she brings her experience from a very successful 11-year run at Limited Brands. 2015 is going to be a year of hard work and getting the brand back on track. I'm very pleased that we have the team largely in place who will be doing that work. That said, I am bullish on where we are overall as a company. The consistency of performance that we've seen with Old Navy really premised on the back of season after season good product that is on trend and on brand gives me a good deal of confidence. It's the product of work that Stefan and the team have done around how they think about trend, how they build the assortment, and how they line up all elements of the business to express the brand consistently through marketing, product, and in stores.
I'm very happy with what I'm seeing with the team at Banana Republic. Andi has excellent taste. She understands the brand, and she has been one of our most consistent operators inside the company, having worked directly with me in a number of roles. Andi and I both expect more from the brand. April is Marissa's first product flow. We saw fall presented last week at Fashion Week to a very good reception and reaction. We are committed to continuing to move Banana forward.
The proof is always in the product that we're putting in the stores, but we're excited about what we see and have high expectations. Let me spend just a moment on Athleta. We're excited about what we're seeing there, and we're excited about the continued growth both in the active space and in the space where active meets her ready-to-wear wardrobe. You also have seen, given how excited we are, the fact that we continue to push on fit inside of Gap and on the active expression inside of Old Navy as well. This is a space that not only through Athleta, but as a company we are very committed to. Over the course of 2014, we made significant progress in the omnichannel space, and we're very excited about the customer response there so far.
We're pushing forward to roll out all of the capabilities across our brands in North America as quickly as possible. On top of omnichannel, I just want to spend a moment really more broadly on experience. If you've been following some of the changes that we have made, you would have noted that we brought together the traditional marketing activities and our digital business inside both Gap and Banana Republic. Why am I excited about that? I'm excited about that because today, the digital expression of our brand is the primary way that our customers engage our brands. If you look at our traffic, the bulk of our traffic is coming into our digital properties. I am convinced that going forward, we will win or lose at our digital lease line.
Historically, our websites needed to be and have been tremendously effective and efficient channels that our customer bought through. We need to continue to be that going forward, but our digital expression of the brand needs to be more than that. It needs to be aspirational, holistic, emotional in a way that few people have expressed their brands digitally. We are focused on doing that across all of our businesses. I want to spend a minute on global growth. Glenn and I worked shoulder to shoulder to create the strategy on growth, and we've been pursuing it consistently over the last several years. It's my intent to continue to pursue growth and obviously through all of our brands, but most importantly through Old Navy's expansion into China and Japan.
We continue to open stores in China with the plan for this year being about 40 stores, which is consistent with our store opening over the last year or so as well. Let me close just by coming back a little bit to where I started. I am very excited to be sitting in this role. I am very optimistic about the prospects that this company has in front of it. I'm also very honest and objective and have a great deal of urgency about some of the work that we need to do to get parts of the business back on track. I can give you my strong assurance that I and my team are resolutely committed to doing what's necessary in order to make that happen as quickly as possible. Thank you. Katrina, I will pass it back to you.
That concludes our prepared remarks. We'll now open up the call to questions. We'd appreciate limiting your questions to one per person.
Thank you. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, please press star one to ask a question. We will go first to Barbara Wyckoff with CLSA.
Hi, everybody. When will Gap and Old Navy be in a place where they can react in season to accelerate the flow of best sellers through the fabric platforming initiatives? If it's not happening yet, when will this start to occur? Thanks.
Hi, Barbara. It's Art.
Hi.
Thanks for asking that. I really appreciate it. Here's the reality is that we're actually set up to do that today, and we're continuing to grow that capability, not just in Gap and Old Navy, but across all three of our big brands. It logically connects to the question, obviously, of the port situation. I want to address that proactively here, which is that with Gap in particular, well, the port situation, for one thing, that is something that is very short term and really outside what we've built in terms of our responsive supply chain. We've reacted to that through logistics, and I'll let Sabrina talk more about that. I'm sure that will come up.
With Gap and the aesthetic corrections that we need to do, what I'd like to be able to tell you is we can correct it with the responsive supply chain capabilities that we've built. The reality is that when we're more rebooting some of the aesthetic elements of the brand, those are capabilities that are set up to help us more in season with chase and open to buy and those types of things.
Right.
It's really a little bit disconnected from the problem that we have in Gap right now. I'm working very closely with Sonia Syngal, who is our head of supply chain and product operations, as well as the brand presidents. These are capabilities that we've talked about before. We're continuing to build them, and we're very bullish about their ability to impact the business.
Great. Thank you.
Yep.
We will go next to John Morris, BMO Capital Markets.
Thanks. Yeah, I guess kind of a big picture question for you, Art. You touched on a number of the initiatives. I think we can get a pretty clear sense of the priorities you've got mapped out. Clearly, likely beginning with Gap Women's. Beyond that, maybe, first of all, if you could talk a little bit more about how you would rank those other priorities, what you really want to address in the coming year, but also an eye towards any initiatives this year that might be different from the course that was charted most recently in the past under Glenn. Thanks.
Sure, John. Thanks. Clearly, Gap is at the top of my priority list. As I said a few minutes ago, none of us are happy with the performance, not me, not Jeff, not the team. We're very focused on fixing that as quickly as possible. If I look back and step back from that a little bit, as Gap is doing that work to fix itself right now, there are the broader strategic priorities, and we'll talk more about those obviously over the course of the next several months. I would remind everybody that I think I'm day 26 or something like that, so still bringing the team together. That all said, and I've said this before when we spoke a quarter ago
I don't want to communicate at all that there's going to be a big shift in our priorities. Product is absolutely critical to us, and underneath product as a priority, our responsive supply chain capabilities, our seamless inventory capabilities, fabric platforming, obviously design and design talent, all super critical. When I am talking product inside and outside the company, it's on-brand, on-trend product, but consistently. That consistency issue is one of the things that I'm really focused on. Then the second issue is really, for me, it's experience. Under experience, it's the omni-channel, the physical, and the digital experience, and how all of that comes together. It's really about, in my words, powering up our focus on those as much as anything, rather than deviating from them.
Of course, global growth, which I referenced, I just want to come back to, which is we're committed to continuing to build out our global structure, and to put consistent product into it appropriate to our brands and on trend season after season. Not a lot of deviation at all from those as our priorities.
Thanks. Super helpful. Thank you, Art.
Yep.
We will go next to Adrienne Yih with Janney Capital Markets.
Good afternoon. Art, I was wondering, obviously, it goes without saying that product is paramount, but if you could address where you see further opportunities to incorporate technology into the business to either drive sales or improve and enhance the operational aspects of the business. Thank you.
Yeah. I appreciate the question. That was a good one for me, since I'm passionate about this as well as a number of other things. I think as we said, we're really continuing to push these omni-channel capabilities, which have been for us more what I would call spot capabilities. Reserve in store, shipping from store, find in store. Now we are testing mobile POS, which we've talked about before. Knowing now how the customer is reacting to those, having learned a lot about how it comes together to form a customer value proposition, and now starting to integrate them into a more holistic offer. That's really the focus, and it's going to be the focus over 2015.
We're testing mobile POS right now, which is really, as we've been talking about, as we push our POS to really a cloud-based POS that brings all of our web services in. We've been testing that on a small device in stores, and both the sales associates and the customers have been reacting incredibly positively to that. It starts to open up a number of things for us. Different ways of interacting with our customers, giving the sales associate those tools. Different ways of engaging with those customers in the fitting room, where we can actually get a transaction done. Of course, you pivot back to what does that mean to the real estate that we currently have committed. The church that we've built for Easter Sunday, if you will, with all the registers at the front of the store.
Can we start thinking about putting some of that real estate to more efficient use than underutilized registers for much of the year. Those are all things that we're absolutely focused on. It's well past proof of concept, both in terms of technology as well as how customers engage. You'll see us continue to push those out over the course of this year.
Great. Thank you.
We will go next to Simeon Siegel with Nomura Securities.
Thanks. Good afternoon. What's the right way to think about the other segment sales and profitability line as you guys close Piperlime? Then, I guess, any update on the Intermix business and the opportunities there. Thanks.
Yeah. The other growth, the other's primarily going to be Athleta, Intermix, and Piperlime. It is being impacted to your point, Simeon, by the fact that we're winding down Piperlime. That's one of the primary impacts. Athleta continues to be on a very good path, so we're very pleased with the year and how it's all gone.
We will go next to Lorraine Hutchinson with Bank of America Merrill Lynch.
Thank you. Good afternoon. As you think about product purchases for the back half, what are you seeing in terms of average unit cost? Does that have an impact on how you plan on pricing your product in the back half?
Yeah. I'll start with that, Lorraine, and then if Art wants to chime in, that would be great. With regard to average unit cost, we've talked about the fact that spring didn't really have a lot of change, because when we placed spring, there wasn't a lot of difference in the cotton prices. We start to see some benefit in summer, and certainly in the back half. That's all good news. Directionally, though, when you do the math on what component cotton is to our total AUC, and I'll just do something high level and illustrative for you. If you have a 20% improvement in cotton, it equates to roughly about a 2% improvement in AUC, and that's before we make any mix decisions or any other changes to our assortment. It's super helpful.
It's a positive thing, it's not an enormous lever, even into the back half. Again, it's helpful. With regard to pricing, I would say, given the promotional environment we've been living in, there's not really a great case in my view for changing pricing and giving that to the customer. Of course, what we'll be looking to do is trying to return to healthier margins in 2015. That could be a lever, some of it offset by foreign exchange. The cotton tailwind could be a lever. We'll be managing our promotional cadence to try and also support healthier margins in 2015.
Thank you.
Ladies and gentlemen, as a reminder, please limit your questions to one per participant. Your next question comes from Matthew McClintock with Barclays.
Hi. Yes. Good afternoon, everyone. I was wondering if we could focus on Athleta for a minute. Plans to only open 20 stores this year seems like a slowdown from growth over the past several years. Just wanted to think about how you're thinking about growth for that specific brand. That'd be helpful. Thank you.
Thanks, Matt. Art here. I'm actually really glad you asked that question. Let me just step back for a second and talk a little bit about the journey that Athleta is on. Obviously, started as a catalog and then an online retailer. We only opened stores a few years ago. As we've opened these stores, the number 1 store in the market, and then the follow-on stores in that market, we're really learning a lot about building a retailer from the digital world, if you will, into the physical world, and how the two channels interact with each other.
What we've learned is very positive, which is that we can build stores, and we can continue to get the growth out of the direct channel at the same time, which is obviously great growth, accretive growth, and really attractive from that standpoint without having to put physical assets in the ground. I have no modification in my mind in any way, shape, or form about the growth rate and the growth prospects of the business. Just as we're learning about how we get that between the two different channels, we're trying to be really responsible, obviously, and optimize the overall returns of the business by the differential growth rate of the two channels. If you're or anyone is interpreting this as somehow we're losing a little bit of our optimism for the business, that's absolutely the wrong interpretation.
Thanks, Art.
Yep.
We will go next to Kimberly Greenberger with Morgan Stanley.
Great. Thank you. Art, I wanted to ask you about the supply chain, I'm just trying to reconcile two comments that seem a little bit contradictory. You indicated that you've got current capabilities to be able to respond in season to best sellers and adjust your merchandise flows. I think during your prepared remarks, you said that you're basically in 2015 already bought through fall here at the end of February. I'm just trying to understand how those two things happen simultaneously. Is there a point in future years where you think we'll be sitting at the end of February, not bought out for the next six to eight months?
Yep. I think I can resolve the potential inconsistency that you see there. Part of the issue is that, just being very straightforward on this, with everything that's been going on at Gap, they are probably on the lagging side of having implemented some of these supply chain capabilities. Even now with Jeff coming in, Kimberly, we're actually taking a pause, we will be shortening our product calendar, number one, at Gap. Number two, pushing much more aggressively on some of those things that in season or close to being in season allow us to be very responsive, like an aggressive push on fabric platforming and those kinds of things. Why I'm bullish on this, I see this working in our other businesses.
I wish Gap had pushed farther forward because it would give us the ability to be a little bit more responsive right now. They're not as far as they will be very quickly. The other issue is, if you look at it, let's rewind from fall. Fall is sometime probably in early August, so it's actually not that far away right now if you consider the production cycle on ocean time, et cetera. I don't think it's contradictory at all, and we're definitely pushing forward on this. I wish Gap was in a different place, they're the laggard as it's come to implementing this, and that's something we're correcting right now.
Thanks so much.
We will go next to Susan Anderson with FBR Capital Markets.
Good afternoon. Thanks for taking my question. I was wondering if you could maybe expand just on your vision for the Gap segment and what needs to transform there. Do you think it's all product, or is there any other structural pressures going on given the entrance of new competitors? Do you feel comfortable with its store base given the focus on e-commerce and omnichannel? Thank you.
That's funny because I remember sitting in our design center in 55 Thomas in October of 2012. I'm sorry, of 2011. A question was asked that was very similar to that when I was in Jeff's seat. As of February of 2012, when we really had on-brand and appropriate product that was really aligned with the trend of the season, that was the Be Bright marketing campaign that we brought it to market with. Then we saw very good numbers come out of the brand almost instantaneously with getting the product back on track. I'll be honest with you right now, Susan, I'm really much more focused on reestablishing the aesthetic direction of the women's business, and getting product in our stores that reflects what our customers expect, which is product that is feminine, product that has an optimism associated with it.
Obviously, casual product with an American aesthetic. I know there was upside associated with doing that. Then we do that, and that gives us the time to then look at any other issues. I would also just refresh the memory that when I was sitting in that seat, we closed a couple of hundred stores and had made very good progress there from the standpoint of really rationalizing the fleet to be in the kind of real estate that we felt a brand like Gap should be exposed in. Right now, I want to stay focused with Jeff and the team that he's pulled together on getting the product aesthetic right. The other thing I'll say here again is that, as we talk about the product aesthetic, we have a very good men's business.
The kids and baby business remains healthy for us, the GapFit and GapBody business is a good business also. For me, largely, this is a women's business right now, and it's what our focus is on.
Great. Thanks. Good luck next quarter.
Thanks.
We will go next to Oliver Chen with Cowen and Company.
Thank you very much. Art, regarding your focus and your feature here, regarding the aesthetic direction, are you thinking that the women's tops or which classifications might have the most opportunity? How do you think you can kind of attempt to sort of marry the great efforts for consistency versus creative and kind of balancing the art and the science of retail? I'm most curious about the Gap division and what kind of observations we should look for as we check the stores.
Appreciate the question, Oliver. I can see you're thinking about the business in the right way. Not surprising. Right now, as I mentioned, we're seeing a little bit of life in denim. The Revolution Denim has gotten a pretty good reception from customers. They're really finding that they like the whole notion of it, the fit, the fabric, et cetera. Obviously, I characterize it as the customer has taken a bit of a pause in denim over the course of the last several quarters. I would say as much from our business, but also having just been in New York during Fashion Week and seeing what was being talked about, what was in the showrooms, what the news was in denim.
I'm not going to call a turn in the denim business. I'm feeling now differently than I felt for a while, which is that she's probably coming back to denim in a way that we haven't seen her be for several quarters. Encouraged there. It's early days. Tops is tough right now. It's wovens and knits. It's a fit issue. It's a fit intent issue. It's an aesthetic issue. We're very much focused on that and very much focused on fixing that as quickly as possible. If I had to go to one category, I would definitely say it's in the tops business. Obviously, both knits and wovens for Gap brand are very material categories. She's just not responding to the product there right now at all. Let me just stop there.
I mean, that's work that we need to do. On the issue of the tension of consistency and creativity, I actually think that's a false dichotomy, to tell you the truth. Let me just give you an example. Fit. Fit in bottoms. Fit for us, which is a huge issue with respect to a woman's loyalty towards her pants. We should be the experts at fit. We have been the experts at fit, and shame on us when we lose consistency on fit, because then she can't count on us. It also, as you might imagine, has an impact on the digital business, because if she counts on a fit and the fit has changed, then we obviously have an issue with returns right now. Fit consistency is a science. It's a discipline.
In no way does it impede what we need in terms of the great creativity of our design teams. I guess I've worked in other creative businesses during my career, and I've always found that rather than being a trade-off between consistency and discipline and creativity on the other side, consistency and discipline enables creativity, and frankly, takes a lot of the work away from what the team has to do at the end of the day. This is really the reaction I see from our design teams as well, is they want to win, and they want to have a foundation that they can build on every season.
Thank you. That's great to hear. Thanks a lot.
We will go next to Dorothy Lakner with Topeka Capital Markets.
Thanks. Good afternoon, everyone. Just going back to Gap brand again for a second, Art. I just wondered, you've kind of described what you're going to be doing, but what should we look for? What should we see in the stores as we move through this year of transition, I guess?
The words that I use when I describe Gap, which I think are very relevant, are casual, optimistic, and American. If you haven't been in our stores and looked at the women's assortment, I would suggest that you do, but I suspect that you have.
I have.
I would challenge you to find that we are consistently expressing casual American optimism through the product expression that we have in our stores. Those are the words that we're using. Now what does that mean tangibly? In summer, what you will see is it was a very neutral summer that we had last year. You will see more color, brand appropriate color, coming back into the business by the time we get to summer. That's a change that has been made. Print and pattern, obviously, as we get into late spring and summer. Not so much in spring, but you'll see a bit more of that when we get into summer as well. Then as we move into fall, there's a little bit more.
The work that's going on right now on holiday is holiday for Gap is really a time for a very optimistic expression of the brand. At a time when a lot of the industry tends to go to a very dark and neutral place, we have done very good business over many years with a more optimistic expression of the brand during that timeframe. It doesn't mean go nuts on crazy stripe again, go nuts on Fair Isle or some of the other sort of cliché trends perhaps that you see during holiday. We have an opportunity to express the brand in a very optimistic and colorful way there, but also obviously in a feminine way, which is the other piece that's missing from the women's business. I'm not going to call a turn on the business right now.
I'm being very honest with you about the work that's going on and when you will start to see some change. I'm not promising anything till we get later in the year. I think even as we get to summer and the fall, you'll start to see the brand shift a little bit more to be expressed through the appropriate filters of the brand.
Great. That's very helpful. Thanks so much and good luck.
Yep.
We will go next to Thomas Filandro with Susquehanna International Group.
Hi. Thanks for taking my question. Question about the marketing. I think the overall spend was only up slightly. I was hoping you could remind us what the incremental spend was for the Gap brand in 2014. Just, Art, given your digital expression comments, how should we think about $ spend in 2015 and any adjustments to the mix in the spending? Thank you.
Yeah, I'll let Sabrina grab the specific number if she wants to talk about that. I'd rather go to a slightly different place, which is to really talk about this change that we've made in the structure of digital and marketing. It's something that I did very intentionally, and I did it very intentionally in the 2 brands that we did it in under 2 leaders who I know very well and I think are very enlightened and very capable leaders. Now, you're going to want to know what does that mean at the end of the day. Let me just give you a couple things that we'll probably continue to talk about. Our brands are being engaged digitally much more so than through traditional marketing vehicles.
The good news about digital engagement is we have a much better line of sight to the return of our spend in digital engagement versus some of the traditional marketing vehicles like a billboard or a transit shelter or those kinds of things. Part of what I'm trying to do by bringing those 2 things together is to really get our arms holistically around how the customer is engaging our brand, and then start managing that for the highest returns in our overall spend. I'm not going to say that we're going to spend less marketing, but honestly, I'm pretty confident that we're going to be able to see a path towards evolving to higher returns on the marketing spend that we have across a number of different vehicles.
The second thing, which I've highlighted, but I want to highlight again, is that we have had the luxury of living with our digital expressions of our brands, our websites, as being very efficient, transactional channels. Today, to me, it becomes an and, which is those digital properties also have to carry the aspiration and the emotion of the brand, as well as being very efficient channels. By bringing those 2 things together, we really now have leaders in an organization that's going to be thinking digitally first in everything they do. It starts with very simple things, which is if you're shooting marketing assets for traditional marketing vehicles, oftentimes those assets don't manifest themselves in the best way possible for digital use. We just need to pivot to a digital-first mindset, and I do believe we'll get some efficiency out of doing that.
I'm much more excited about the effectiveness of our overall spend that we're going to see.
Thank you, Art.
We will go next to Paul Lejuez with Wells Fargo.
Hey, thanks, guys. As you think about the issues facing Gap brand, Art, I'm just wondering if Gap internationally is facing similar issues, or have they out-comped the North American business? Also specifically, if you could comment on how Gap China has performed, both for the full year and in the fourth quarter. Thanks.
It's kind of a mixed bag, quite honestly. It really depends as a function of a couple of things. Obviously, how the assortment was bought and how a team in a given part of the world put pressure on different parts of the business. In some places in the world, like in China as an example, our kids and baby business index is much higher into the overall business than the adult business, and that business has been pretty consistent and pretty strong. Here's what I would say, is we have had the same product issues that have been the product issues in North America, have been product issues everywhere. In that we have bought the business different and the customer engages the business different.
We've seen levels of strength in China, as an example, that have been better than what we've seen in other parts of the world. I don't know, Sabrina, if you want to talk at all about specifics of the China business.
We don't break out very much. I think directionally that's appropriate. I think we had more success in China, certainly than we saw in North America with the assortment. A lot of that is, Art said, is how it was bought in China and the favorable mix to kids and baby, which has continued to be more of a relative strength.
The other thing I'll say, just to put a period at the end of the sentence, is we're confident that as we make progress in the women's business, it will have an impact around the world.
Thanks, guys.
Yep.
We will go next to Betty Chen with Mizuho Securities.
Thank you. Good afternoon, everyone. I was wondering if we can shift gear for a moment, Art, and talk about Old Navy. Just had a great quarter to wrap up a nice year. As you look at the brand, what are some potential opportunities for the brand going forward and when we may see that play out for 2015? Thanks.
Thanks for the question, Betty. If I just step back and look at the opportunities for the brand, opportunity number 1 is consistency season after season. That's what gets me probably more excited than anything about the fact now that we've had a little bit of a run there with consistent product, which the customer has consistently responded to. I would also really point you to the expression of the brand in our marketing. Probably the best place that I go to, honestly, to see it is on Instagram. I follow Old Navy and our other brands, as well as a number of other brands. There are honestly times when I look at Old Navy's imagery on Instagram, and it's hard for me to distinguish between a premium or a premium contemporary brand in terms of the aspiration of the fashion that we're presenting.
Stefan uses the word masspirational. I think it's a great expression that you see when you see those brands juxtaposed against each other and how Old Navy is really communicating the fact that it's got current trend, that is right where it needs to be right now. Clearly, that's what she and the overall family is responding to. Still bullish, obviously, for Old Navy. That's in the domestic business. Given consistency, there's a long runway in front of us there in terms of opportunity. Very bullish on the international business and the expansion that we have in both Japan and in China. A couple of places worth highlighting inside the assortment. I touched on the fact that Old Navy has a family-wide active expression. We've had tremendous customer reaction to that.
She's really engaged, and she is engaged on behalf of the family, kids, the men's business, and her business, the active expression. That's a place where, if that's a trend, that's a trend that's got a long runway in front of it. We're excited about being able to build out that business. It's a business that is essentially purely incremental for us inside of Old Navy. There's real estate to house the business. We're not having to trade off other key categories. It's a very nice incremental business for us that allows us to build the business, build productivity in the real estate, and give her another reason to come inside the store.
Thanks so much.
We will go next to Lindsay Drucker Mann with Goldman Sachs.
Thanks. Good afternoon, everyone. Sabrina, I wanted to follow up on currency. The guidance that you have for the translational and transactional headwind in this year's earnings guide, does that also include some of the cushion or the protection you got from hedges that have been in place? As a result, as we're thinking about our 2016 model, I know you haven't given any explicit guidance, but as we're looking at out years, should we also be thinking about a currency headwind to factor in? Just as part of that question, this isn't your first moment dealing with currency. Do you guys have an approach, a plan of attack on how to defend margins, whether it's through pricing or cost savings? Have you considered maybe in Europe diversifying your sourcing capabilities to include some local manufacturing or any other initiatives you're taking to protect margins from this?
Thanks.
Yeah. On the first question, it definitely, Lindsay, includes the hedge rates embedded. The guidance includes the hedge rates for 2015. As I mentioned, we hedge 12 to 18 months in advance. The hedge rates tend to lag spot by about 12 to 18 months. They worsened again, but they didn't worsen to the degree that they did coming out of 2013 to 2014. That is all embedded. With regard to how we look at descending margin rate, I would say we look country by country, certainly, and we don't feel like in a lot of our countries, given the competitive landscape and the orientation toward value of the customer, that there's a lot of room to just full- scale increase prices given the increase in AUC driven by the stronger dollar.
What we look at more is how do we affect and address the issue through our promotional cadence, through our sales and markdowns. That's what we've been trying to do overall for the last year and a half as we've been facing the pressure already. We'll continue to look at sourcing mechanisms as well as we move forward, since we'll probably be in a dollar strong environment for a little while here.
Great. Thank you.
We will take our final question from Anna Andreeva with Oppenheimer.
Great, thanks. Happy to have made it. I guess the question to Art, as you think about reinvigorating the Gap brand, how do you think target customer demographic has changed here over the last couple of years, and how do you segment the market between Gap and Old Navy just to make sure the brands are different enough to coexist in the marketplace? To Sabrina, just to follow up on the guidance, are you embedding any of the buyback activity for 2015? Thanks.
Okay. I'll take a quick pass at this, and then I'll hand it off to Sabrina. Let's be clear. We participate in an almost $2 trillion global marketplace for apparel and accessories. As a company that has $16 billion roughly in revenue, there's a lot of space out there. As to the target customer for Gap, I think I am less focused on the target customer than I am on the fact that Gap, at its best, has historically been a pretty democratic brand. What gives me the greatest pleasure is to see a woman with her daughter, either a young daughter or her adult daughter, shopping in the brand. That is exactly what we saw back in 2012 and in 2013, when we had product well-priced, appropriate for the brand that was on-trend in our stores.
I'm a little less inclined to embrace sort of the two-dimensional cutout of a target customer rather than great product that's right for the brand and for the aesthetics filters of the brand will power a good business. As to our brands competing with each other, my basic perspective on that is get the best product you can through your brand filters, and there's a lot of competition out there to go and beat. I'm less inclined to think about our brands competing against each other than competing with both fists against our competitors and winning every day. Sabrina?
Yeah, briefly on the buybacks. Our range always includes various scenarios. Given our track record, I think it's safe to say our scenarios would include some level of buyback.
Great. I'd like to thank everyone for joining us on the call today. As a reminder, the press release, which is available on gapinc.com, contains a full recap of our fourth quarter results, as well as the forward-looking guidance included in our prepared remarks. As always, the investor relations team is available after the call for further questions. Thank you.
That does conclude our conference. Thank you for your participation.