I would now like to introduce your host, Katrina O'Connell, Vice President of Investor Relations.
Good afternoon, everyone. Welcome to Gap Inc. Q1 2014 earnings conference call. I'd like to remind you that the information made available on this web 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 press to GAAP Financial Measures, please refer to today's 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 May 22, 2014, and we assume no obligation to publicly update or revise our forward looking statements. Before we begin, 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 Chairman and CEO, Glenn Murphy and Executive Vice President and CFO, Sabrina Simmons. Now I'd like to turn the call over to Glenn.
Thank you, Katrina, and good afternoon, everybody. Before I hand the call over to Sabrina, who will take you through Gap Inc. 1st quarter financial performance, I thought I'd give you my thoughts on Q1 and also remind everybody on the call of Gap Inc. 4 global priorities. Everybody here was actually pretty disappointed in our earnings results for the quarter And we were below last year and that hasn't happened to us since the Q1 of 2011 and that was driven by the cotton crisis.
So in spite of the fact that the operating conditions were challenging, especially in the first half of the quarter, I expected that we would do better. Now upon reflection, we've been doing this now for the last number of weeks, looking to business because our business is all about continuous improvement. And what are we going to do to move our business in the right direction? The product was a little too spring forward and something that's in our control. I think our customer communications could have been better and that's also something in our control.
And our margin management, I really thought the team could have done a better job working through the inventory we had, especially as it got backed up after the month of February. I think we could have done a better job managing our margins in the quarter as well. All three of those points are completely in our control in areas that the business has embraced and are making the necessary changes as we come into Q2. With that said, I think we have pretty good plans across the business in the second quarter. We're in the business to gain share.
And our goal is gaining share in the Q2, Q3 and Q4 to finish the year strongly. When I look at the business, Old Navy is the one brand that's furthest along. I think that they've made some really good decisions and that's evidenced by their performance in April, which was a +18 comp and that's pretty strong. They've made some really good decisions on their assortment. It's rooted in fashion essentials.
And I like what I'm seeing as they evolve and improve their assortment between now and the end of the year. And when I think of their marketing going forward, I like what the team's done. They got a really good creative platform right now at Old Navy. I think it's going to become even more compelling as we move through the year and more aggressive. And the Old Navy team is revamping their whole online site, which you'll see next month.
So I think their digital presence will be even stronger going forward. Now Banana Republic, the good news in that business is that women's has turned the corner. Seems like that's been a long journey, but we haven't gone in the right direction and customers will truly notice the difference in our August delivery and everybody in that team and myself are pretty excited about that. Marissa Webb joined Banana Republic starting in the 1st May. Now Marissa's impact on product is not going to be felt immediately, but seeing as how she's our Creative Director, her impact on our messaging and the voice to the customer, whether it's on social or in other tools, we felt around the same time as you see this lift and this improvement in our women's product in August.
Gap is definitely headed in the right direction, but still has work to do. Steve and the team know that. What I'm looking forward to with them is they're moving to a full global assortment in August of this year. That's across the business. It's a complete change from where how we assert today and how we do that globally.
I think that's going to really help their business go out and differentiate themselves and gain share. And coincidentally with that, we'll be the 1st campaign we're going to have globally from our new ad agency, Weidman Kennedy for Gap. Now as I promised at the beginning of the call, I want to give you update on Gap Inc. Global priorities. There are global growth, omnichannel, responsive supply chain and seamless inventory.
I spent quite a bit of time at the recent analyst meeting explaining to everybody why we chose these initiatives and the value we're going to create for Gap Inc. Shareholders going forward as each one of these become part of how we operate every single day. I feel good about the value creation and as you look at each one of them, the global growth initiative, 250 new stores this year. That's a combination of corporate and franchise. That's a high watermark for us.
So far so good in China, still good performance, comp performance and new stores going into that marketplace, 20 new cities in 2014. Old Navy performance so far in the franchise market in Philippines has been very good, excited about what we're seeing in Shanghai with the 1st Old Navy store opening. And the only news is that in the last 30 days, we've added 5 new Athleta stores to our planned list and our guidance. And now we're going to open 35 Athleta stores in 2014, which will allow us to end the year with 100 Athleta stores. On the omnichannel front, Reserve in Store has been rolled out to 500 Gap stores.
I just started a few weeks ago. So now on top of those 500 Gap stores, when 400 Manor Republic stores, The marketing just started behind that to start telling customers because if anybody tries it loves it. And our goal is to get awareness and trial behind it. And we will be piloting next month order in store. If you look at the apparel business, there's a conversion number and then there's customers who come in and don't convert and a portion of the customers who don't convert, it's because couldn't find their size, couldn't find their color, couldn't find exactly what they were looking for.
So this pilot is digital, it's quick and our employees are able to carry that with them on the floor to close the sale. And lastly, on the sponsor supply chain, we've had meetings, Sabrina and myself, for the last 30 days to get updates with each one of the brands, really good momentum. There will be some benefit to our operating margin in 2014 in the back half and will really benefit 2015. So the momentum is moving in the right direction. Now I want to close by telling everybody we're still very confident here.
We mentioned that last month, but we're confident in our full year guidance. We're committed to our full year guidance. So if you allow me just a little history lesson, in 2008, 2009 during the depths of the recession, we did better than pretty much any other retailer by managing our P and L, managing our cost during difficult consumer times. In 2010, when conditions got a little better, we had a very strong top line and we hit a record operating margin in 2010. 2011 when the cotton crisis hit, that was not our best year, but we bounced right back in 2012 'thirteen.
There were some operating condition challenges in the Q1 2014. So given the character of the company and how committed we are to delivering on our promises to one another and to shareholders, I have all confidence we're going to bounce back in Q2 and beyond and deliver on the guidance we put forward for 2014. So with that said, let me hand over to Sabrina.
Thank you, Glenn. Good afternoon, everyone. Despite a challenging start to the quarter, we continue to focus on levers that drive long term value. We made progress on our strategic initiatives, including launching Old Navy in China, Gap in Taiwan and opening additional Athleta stores. And we did this while maintaining our operating expense discipline.
Regarding earnings for the quarter. In the Q1, operating income was $443,000,000 versus 5 $30,000,000 last year. Net earnings were $260,000,000 and earnings per share were $0.58 versus $0.71 last year. And as a reminder, we were lapping $0.04 of benefit to last year from the favorable resolution of tax issues. Additionally, we estimate that the impact from foreign currencies reduced our reported EPS growth rate in Q1 by about 5 percentage points.
Sales for the Q1 were $3,800,000,000 up 1%. Comp sales were down 1% for the quarter. The translation of foreign revenues into dollars negatively impacted our reported net sales by about $20,000,000 in the Q1. On a constant currency basis, net sales were up 2%. Total sales and comps by division are listed in our press release.
Moving to gross margin. 1st quarter gross margin was down 260 basis points to 38.8%. Merchandise margins were down 2 30 basis points for the quarter, driven by a challenging February March, which put pressure on our ability to move as many units early in the quarter. Importantly, we did end the quarter with inventory in line with our guidance. Rent and occupancy deleveraged 30 basis points.
As a reminder, we need positive comps to leverage rent and occupancy, and the threshold for raw leverage is higher this year, likely a low single digit comp, given our mix shift toward international markets like China that have higher rod costs. Regarding SG and A, 1st quarter total operating expenses were $1,000,000,000 up $9,000,000 from the prior year. Marketing expenses were flat to last year at 143,000,000 dollars As a percent of sales, total operating expenses leveraged 10 basis points versus last year to 27.1%. Regarding the balance sheet and cash flow, inventory dollars per store were up 7% at the end of the first quarter, in line with our beginning of the quarter guidance. For the quarter, free cash flow was an inflow of $351,000,000 and we distributed $328,000,000 As part of that distribution, we used $219,000,000 to repurchase 5,600,000 shares, resulting in quarter end share count of 443,000,000.
Regarding capital expenditures and store count, 1st quarter capital expenditures were 162,000,000 dollars We opened 15 company operated stores on a net basis and ended the quarter with 3,179 stores. Square footage was up 0.5% compared with Q1 2013. Store count and square footage are listed in our press release. And now I'd like to share our outlook for the rest of the year. Our objective overall continues to be delivering modest positive positive comps on a full year basis.
In addition to our comp base, we plan to drive increased revenue through our multiple channels, newer brands and geographies. Given our remarks just a few weeks ago, I'm sure it comes as no surprise $2.95 At its midpoint, this equates to 7% full year EPS growth on a reported basis. On a constant currency basis, the growth rate is estimated to be 5 percentage points higher or a solid double digit growth rate. Underlying this guidance is the following: first, the expectation that we make progress against our goal of tightening our inventory levels with each quarter. At the end of Q2, we expect year over year inventory dollars per store to improve by a few points versus the year over year increase in Q1.
2nd, the expectation that our supply chain initiatives will begin to deliver benefits in the second half of the year, especially at Old Navy. Finally, we remain committed to managing SG and A in a disciplined manner. However, recall that leverage is likely to be very modest this year as we moved a portion of our credit card income out of SG and A and into gross margin. For the full year, the following guidance metrics remain substantially unchanged. We expect operating margins to remain flattish on reported basis as foreign exchange is negatively impacting our margins.
As a reminder, foreign exchange impacts our earnings in 2 ways. The first is translation and the second is the impact to our merchandise margins. Our largest foreign subsidiaries are in Canada and Japan, and depreciation of those currencies negatively impacts our cost of goods and therefore our reported results. We continue to expect square footage to be up about 2.5%. We still plan to open about 185 company operated stores and close about 70 net of repositions.
Store closures are weighted toward Gap North America and store openings are weighted toward China, Old Navy in Japan, Athleta and Global Outlets. We expect capital expenditures to be about 750,000,000 dollars and depreciation and amortization to be about $520,000,000 We expect our full year effective tax rate to be about 38.5%. In closing, as we enter the 2nd quarter, we will continue to focus on levers that we can control, like expenses and inventory, while we work to deliver compelling assortments. And we're encouraged by the recent turn in momentum at our largest brand, Old Navy. Thank you.
And now I'll turn it back over to Katrina.
That concludes our prepared remarks. We'll now open up
the call to questions, and we'd appreciate limiting your questions to 1 per person. Thank you. And we go to
our first question from Adrienne Tennant with Janney Capital Markets. Hello, can you hear me?
Yes.
Congratulations on the great start to the year in a very difficult environment. My question is on the inventory change as we go into the back half of the year. Obviously, it's going to improve heading into the Q3. I was wondering, are you making any concessions for what we are now hearing about the West Coast port issues? And then secondarily, Glenn, can you talk about the global GAAP merchandise changes and what gives you the confidence?
Obviously, probably May is improving, but some of the changes there, what gives you the confidence that everything is sort of encapsulated in Q1?
Inventory piece, Adrienne. So we're very much on track to meet our goal of improving inventory position as each quarter goes by. So in a tough quarter, we're pleased that we met our beginning of the quarter guidance for end of quarter inventory, and we've just guided that it's going to improve by a few points at the end of Q2. We'll guide later to Q3 and Q4, but we intend to stay on the path of continuing to tighten as the year goes on. So committed to that, that's inventory.
Regarding the port situation, of course, our logistics team is monitoring that situation very closely. We hope, of course, that it's resolved. But in the meantime, we're very much working through contingency plans. As you know, following the industry for a long time, it's not a situation we haven't faced before. So we know how to work our plans and how to kick into contingency, but we are hoping for a good resolution to that in June.
Hi, Adrienne. Thanks for the congratulations. I'm not sure it's really deserved, but I appreciate it. Well, I
will say it Old Navy.
All right. We'll take Old Navy in the month of April. In terms of Gap Global, we were talking and I'm not sure we've talked about this our investors, but I know amongst ourselves, when we went to our new global model and made the changes that we did, the 1 quarter we did circle with ourselves was Q1 2014 for GAAP Brand, just because there were so many changes that were taking place and so many moving parts that were going on just 12 months ago. I've got a lot of faith. I've got a lot of belief in Rebecca Bay.
And Rebecca in the Q1, because some of those transitions were going on, look, we executed the best we could. But in fairness to her, she wasn't facing off with a senior merchant. She was facing off with more junior people at the time and transition. She didn't have a head of women's. So I think the Q1 with a lot of moving parts and the fact Rebecca was not surrounded by the kind of supporting cast that I think every great creative director needs, we didn't have our best Q1.
And I think things got a little bit better. I think the product in store right now is slightly better than what you saw in the Q1. I think June gets better and especially as I said in my opening remarks, August, as we move to a full global assortment strategy that Steven Sunnix and Michele DiMartini, who is now the senior partner to Rebecca on the merchandising So I think Michelle has got 20 years of experience in our business. I think that I'm not saying to wait till August. I'd say in August, there is a moment where we go to 3 key assortments around the world, completely simplifies our business.
That's very clear how we have our good, better, best strategy across those three assortments. But I've got a lot of faith in what Rebecca, now her full team and she has everybody she needs are going to get done. They know they didn't have the best Q1 and they're accountable for it. But I think that we get better from a pure product to the consumer as we move into the later part of summer and certainly in the fall. That coupled with the marketing I talked about in the opening comments, I'm counting on Steve that that combination will be the magic to get that business back on track.
Great. Thank you very much. Best of luck. And we move next to Lorraine Hutchinson with Bank of America Merrill Lynch.
Thank you. Good afternoon. Your consumer has a
lot of loyalty to your fit around the world. And I was just curious to hear about the extent of your testing before rolling out a global fit to some of your brands.
It's actually more intense and extensive than I would like it. This is probably the nature of our culture. But when it came to we had some experience, Lorraine, when I started, we had a European fit, a Japanese fit and an American fit. And as we started making decisions collectively as a team to move to a global structure, we first dealt with the European fit and that there's a little bit of gross margin wrapped into that in order to liquidate the product properly through Europe and it introduced the American fit, let's call it, which is now the global fit. And then Japan, we took a little more time.
And what we're finding out very clearly is we've had to make some very, very minor tweaks to what is now the global fit as we brought Japan in. But all the testing we did with current customers, lapsed customers, new customers on the 2 fits, the new global fit and the old Japanese fit, which we did over a year ago. Overwhelmingly, people went for the global fit. And the difference for us now is managing the size curve. Funny story, we just had Board meetings this week and I was talking to members of the Board when I was in Southern China and then went to Japan right afterwards, I found an extra, extra, extra small.
And I made a phone call to find out that wasn't a manufacturing production issue, but no, that's the size curve at work. And so in certain markets that size is prevalent. So in Southern China and parts of Japan, we don't even have extra larges. The highest size we go to is large. So the size curve really gets managed beautifully from the global team, the team we have in New York.
And I think that so far so good, not heard anything. And then we still got to make sure certain styles that are very Japanese styles like men's crops, which we don't sell anywhere else, but we sell that in Japan. That's still part of the global assortment. And so I think that we want to make And so I think that we want to make sure we preserve products that resonated in local markets, but got to a global fit. And you know the reason behind it, besides the simplification to our business, it's the only way to get the seamless inventory.
Great. Thank you. And we go now to Paul,
Great. Thank
you. And we go now to Paul Lejuez with Wells Fargo Securities.
Hey, thanks guys. Just thinking about fabric platforming in the second half, I think it has several benefits. I'm wondering if you could just talk about the benefit on the AUC side of the equation and when that starts to kick in? And then just second, within Athleta, just wondering which categories in that business are performing best, which are lagging? Thanks.
I'll start with the fabric platforming, Paul. Certainly, we're making traction on that. So we have gold ourselves internally since we're taking it very seriously. And we are marching to the goal we set ourselves internally with regard to how much fabric is getting platformed for 2014. With that certainly should come, some average unit costing benefit and that starts in the second half indeed.
What I would say though is we called out that for all of 2014 AUC isn't a big headline either in terms of headwind because of labor or tailwind because of our tools. I mean, I would say we're managing and we're using the fabric platforming as a critical tool to manage other issues like labor pressures, etcetera. And really, the AUC is going to come down to a matter of how our merchant teams and our designers choose to mix the assortment. But we feel, again, like everyone is being quite responsible and that average unit costing overall, therefore, doesn't become a headline.
Just to add to that, we started about a year ago with fabric consolidation. I think I may have said in one of the calls when we started doing some comparisons between ourselves and our 3 other global competitors about how many fabrics we actually use in any given year was, to say the least, embarrassing. So we knew that our creative directors and our designers would still have all the flexibility we want in the world because as we dealt directly with mills, which was the second change we made, their ability to treat the same base cloth in so many different ways was moving at a very fast pace, and to be quite frank, above what we thought was actually doable for some of the leading mills in China, especially. So consolidation then went to fewer mills doing the work for us. We built these mill relationships and then got to what Sabrina just talked about in terms of platform, which has an AUR and an AUC benefit over time.
On that Athleta, it depends on the time we're talking about in Q1, which they had a good performance in Q1. The best performing business in terms of pure comp, not in terms of its contribution to the overall business, but just comp was what the trend itself has been out there for about 6 months that our other brands are capitalizing on little later than Athleta. And that's just the new definition of sweatpants, streetwear, soft dressing. And I think Nancy and the team just did an excellent job jumping on that. And it's so perfect for Athleta as a complement to could be either during or as you're performing an activity or could be what as they say in this business, the to the activity or from the activity.
And that business provided an incredible level of growth for Athleta. Now all of it really matters to me when it's all said and done, there's these periphery categories, that's not one of them, could actually be turn out to be a permanent category for Athleta as it should be a very strong trend going forward for Old Navy and for Gap. But what matters to me is the performance business, what's all said about we have a nice swim business, we have these other complementary business, but what matters to me is performance, performance, performance with a fashion twist. And that business was also ahead of its all store comp. The performance category still did better than the all store comp.
So I'd say the category want delivered the growth we needed. And this new, which again could end up being 2 years, 3 years worth of growth coming from the new streetwear trend for Athleta and its type of customer, I think that could be very, very good for that brand. Thank you, guys. Good luck.
And we move now to Kimberly Greenberger with Morgan Stanley. Great. Thank you. Glenn, you talked about your speed pipeline a little bit at your Analyst Day. And I know you were hoping to see some impact from that pipeline in in the first half.
That looks like it will come in the second half. Can you just help us understand the percentage of your inventory flows in the second half that will come through that speed pipeline? And then if you could look out over the next 2 to 3 years, ultimately, when it's up and running and fully adopted throughout the organization, what percentage of your inventory do you think you could actually flow through that pipeline? Thanks.
Well, there's what I think and what I believe and then I'll probably just answer to you what I believe is actually going to happen because I'm such a believer long term in all of the response to supply chain initiatives we're doing. I know the brand presidents are as well and their teams. Speed is something that the recent investor meeting, we didn't spend a lot of time talking about to be quite honest. It's being used by our 2 outlet teams very well because they're simple, they're quick, they're nimble teams and speed has been very important to them. My view of it is that now that we have fabric platforming pretty far down the line and we've got test and respond in a little bit in the back but very, very strong in the first half of twenty fifteen.
Then the next priority is to have rapid response, which as you know is a longer living style, call it 24, 26 weeks, where after the 1st 10 or 12 weeks as we have a read, the 2nd or third flow get adjusted based on real selling patterns as opposed to decisions made by the merchant and inventory management team. So you get the first flow is put out, you get a read and then you adjust the second and third flow. Speed pipeline, the world class number out there, let's call it less than 12 weeks, is somewhere between 40% 50%. And we are in the lowtomidsingle digits. In my world, Kimberly, I think I don't see why with everything I know about our business and the direction it's moving and our aspiration to get to a much higher operating profit going forward, while the other three components of response to supply chain will certainly contribute to that, I think speed is going to have to get somewhere between 15% 20% of our business to really add great value.
And I think we talked a little bit in the investor meeting about culture. I think the culture understands it, is behind it, knows it's right. They're just going to sequence it likely as the 4th priority under response to supply chain initiatives. Probably get a little bit of benefit next year, mostly if I was to characterize it for you, I think in the second half of twenty fifteen as an initiative under responsive supply chain, I could see where speed becomes a bigger part of our business.
Great. Very helpful. Thanks. We move now to Janet Kloppenburg with JJK Research.
Hi, everybody. I had a question on your marketing advertising spend.
Several of
the companies that I'm following as they transition to the digital platform and yield more sales from that channel are gaining some efficiencies in marketing because it is less costly in that channel and some of the social media venues. And I'm wondering if that's an opportunity that marketing can actually increase, but cost savings may be inherent because the channel mix is changing, especially because of the great growth in your omnichannel investments? Thank you.
Yes. Janet, we are starting to make those very transitions, and each brand is sort of at a different stage. I would say Gap has taken a big lead in moving to digital. We haven't done TV in a little bit of time there. Old Navy actually surprisingly, which has for years done the lion's share of our TV marketing and sort of traditional circular marketing as well.
We started talking about in the back half of last year how they started to actually bring television down. And speaking of that, in Q2 coming up here, we'll have 2 weeks less of television because we are reinvesting that money in other vehicles, including not only digital, but also our in store and our windows, etcetera. So we are starting to make that shift. I continue to encourage the teams to look holistically at the spend because I think we're getting with the same spend. So we just finished a quarter where marketing spend was equal to last year.
I would say for the same spend, we're getting, to your point, a lot of good exposure in marketing, both all through our digital platforms as well as our traditional platforms. I think we can actually drive efficiency, to your point, over time and spend less as we shift to some of these other mediums. So I think that is a discussion that is being hotly debated every single quarter as we move forward here and the teams are definitely looking at all of that.
Okay. And I don't know if you revealed this or not, but for the August campaign for Gap, would that be a TV campaign or some combination of TV and other venues as well?
For this coming August, more to come on that. As you know, we're in transition with a new agency. So that is still in development. But we're definitely going to have a lot of digital materials that can be used for our websites for a lot of different mediums. So in progress and more to come.
Great. I look forward to it. Thank you.
Our next question comes from Oliver Chen with Citigroup.
Hi. Glyn, regarding your early comments on opportunities, you spoke about customer communication. I was just curious if you could elaborate there on where you see opportunity and what levers it would drive in terms of the business? Thank you.
Yes. My take, Oliver, was that given the operating conditions that we dealt with in the first half of the quarter that we took a step back in our customer communication, that's less to do with Janet's question on mediums and content and how to actually get that out through social tools or other tools. I just found that we became reactive, a little defensive and used traditional means to communicate value and to drive traffic, which is percentage offs way too frequently. And we're too good a company for that. We have very strong brands.
Certain brands out there that we either compete against or near us, but we don't have a direct competitive opportunity with. I get that if you're on the strong brand, then you have to make up for it with more traditional ways of driving customer attention and driving traffic and conversion. But when in your portfolio, you have Gap, Banana Republic and Old Navy, I just have higher expectations, I said in the opening. And if you look at the businesses that did do that, that found the right balance between our enlightened and provocative customer communications because the customer is looking for that these days, found the right medium and struck the right balance between that and a value proposition that wasn't predictable, we had a very good business. Case in point, I mentioned Athleta, we don't give out their comp, but they had a very good Q1.
And Old Navy. Old Navy hit a little park in April because they struck the absolute great balance between provocative customer communication and a unique way of presenting value. And the other brands know that and they're going to do that going forward. I mean, this is what we expect of a portfolio where we have 6 brands and 3 iconic ones not to be treated like just any brand. So higher expectations going forward.
I think teams know that. And when they do do it, it takes a little bit more work and it involves more creativity and innovation and thought when they do do it, our business and our customers respond. So we'll be I'll be watching very closely and making sure that they get back on track that we expect in the next three quarters.
Thank you. Best regards.
We go now to Jennifer Davis with Buckingham Research Group.
Hey, guys. Good afternoon. I was wondering if you could talk a little bit about China. I mean, I know you have invested in it and I think the largest part of your investments are over. But I was wondering if as a region it's profitable or if there's a certain number of stores that you need to get to that level.
So if you could just talk a little bit about that. Thanks.
Well, we have said for the last 3 years that it would obviously be a drain on our earnings as we made investments in people. We have an office now of 175 people in Shanghai, made significant investments in marketing, because as I was mentioning to Oliver's question earlier about brand building, that's especially important. You can get lost in a sea of commodities and in apparel in China if you're not careful. Look, I think that the business is really strong. We feel really good about the comp performance of our existing stores.
That's now a pool, soon to be a pool of 82 stores sometime in 2014. We have 30 more stores going in this year. We'll have 5 to 6 Old Navy's by the end of the year. All of them have online capabilities and went into Taiwan. I think by the amount of capital we're spending there, the amount of energy you're getting at the most senior level of the company, China reports directly to me, I think it's a real strong indicator to our shareholders and the analysts that we believe we've got a tiger by the tail.
And we think that's going to be by far our 2nd biggest market sooner rather than later. And feel good about the performance all around and profitability is going to be there because we think that the economic model as we project forward and look at the productivity in each one of our stores, we look at the gross margin rate we think we could achieve based on 3 years of operating, how the SG and A is going to flow, what the rod is going to look like. We believe the economic model for China is going to be very attractive to the business. But we're not going to sacrifice, which we may have made that mistake going into new countries in the past, especially with our franchise markets. We're not going to sacrifice the near to mid term investments for real great long term business.
We feel very good about it. We've got a great team there running it and we're going to continue to make investments. But when it turns to profitability, I'm not here to declare a date, but when it does that, it's going to move very quickly into contributing profitable country as opposed to what it is today.
Yes. And just a dynamic to keep in mind, Gap is improving in its profile every year. And so it's not very dilutive if you just look at Gap brand. But of course, we just launched Old Navy. So you kind of have to consider the fact that each brand launch also consumes, to Glenn's point, a meaningful amount of investment to establish the brand in the right locations with the right marketing.
But if you think of Gap brand alone, it's definitely making progress toward its path to profitability.
Okay, great. And should think of that as kind of eventually similar operating margins or potentially higher operating margins than North America?
It's a little soon to tell. I mean, I guess our thesis coming in was that it's going to be a strong, very strong online market and that's proving out. And as you know, that's an operating margin in that channel is over and above our bricks and mortar business. It's a little that one I'm pretty confident, disproportionate, so we have very strong online business. The outlet channel, I still believe long term that it's going to have multitudes, hopefully more than 100 very good outlet centers and that also is an operating margin over and above our bricks and mortar business.
That one you're going to see how that one plays out. It's not heading the same trajectory. I might have assumed 2 years ago, it's good and we're going to open 8 or 10 a year for the foreseeable future. But I'm hoping that will pick up as more developers from outside of China, including Chinese developers, build these amazing outlet centers. The 10 or 12 in right now are fantastic and we just think of the right mix of tenants.
So we'll see how that plays out. But yes, like for us, if the productivity per foot is better than average, then most cases you can assume we can get a better operating margin for a total country than we have in North America. So let's hope that the sales per foot in China continue to rate throughout right now.
All right, great. And thanks and best of luck.
Thank you. And our last question will come from the line of Matt McClintock with Barclays.
Hi, good afternoon, everyone.
Hello.
Glenn, I was wondering if you could talk about, I know it's a little early, but if you could just talk about, you have a lot of initiatives going on, whether that be, the global Gap assortment, reserve in store, order in store, etcetera. How do you think about the holiday season or this holiday season, how you plan to address that given that you have so many different initiatives going on, so many stories to tell, in so many different ways to tell those stories? Thank you.
It's actually a good question. What I can tell you, we may have said on the February call that we really thought we could have done better in holiday 2013. A little bit to an earlier question, I'll use the same word, but I think we're a little too predictable in our holiday assortment, our holiday messaging. And look, this is a good customer relatively speaking, but they're not they need a different kind of communication than the customer of 2,007. You got to reach out in a much more different way.
They need to really be inspired and engaged in order to participate in your brand. We came back in January and the teams right away got in what was fresh on their minds into holiday 2014 planning. So what I can tell you is I think that we're making the necessary adjustments. It's not we're not quite blowing it up, but we are severely changing how we're going to deal with holiday 2014, starting with product. We're definitely going to change the cadence in which we speak to customers and basically looking at a November 1 to December 24 timeline.
We know it's a global business. So it's not like the opportunity for us is only in North America. It's a global opportunity to do the right thing in the holiday season, marketing, mix of channels, delivery schedules for online. I think we've torn the whole thing upside down the month of January and we're really working hard. It's a very important quarter for us that we want to make sure we end strong because ending strong in a lot of cases means you can start strong.
So a lot of great work has gone on to get ready for Q4 and I'm happy and maybe in the call in August to fill you in more.
Thank you very much.
Great. I'd like to thank everyone for joining us on the call today. And as a reminder, our earnings press release, which is available on gapinc.com, contains a full recap of our Q1 results as well as the forward looking guidance included in our prepared remarks.
And as always, the Investor Relations team is available after the
call for questions. Thank you. Thank you. That concludes our conference. You may now disconnect.