Today's call is being recorded. I would now like to introduce your host, Katrina O'Connell, Vice President of Investor Relations. Please go ahead, ma'am.
Good afternoon, everyone. Welcome to Gap Inc.'s third quarter 2013 earnings conference call. For those of you participating in the webcast, please turn to slide two. 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 were required to reconcile to GAAP financial measures, please refer to today's press release, as well as our most recent annual report on Form 10-K and our most recent quarterly report on Form 10-Q, all of which are available on gapinc.com. These forward-looking statements are based on information as of November 21st, 2013, we assume no obligation to publicly update or revise our forward-looking statements.
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, good afternoon, everybody. Before I hand the call over to Sabrina, who will take you through the key metrics in our third quarter, I just want to give you a couple of opening comments. This was our seventh quarter of positive comps, we feel good about that. A very important part of what we've been talking about, mostly internally, is the momentum in our business, gaining market share, that's been important for us. This was a 2-year comp of seven. I think it was a good performance for Gap Inc. The difference between good and great in this quarter was that in Q3 of 2012, we had a very strong quarter in colored denim at Old Navy and Gap. It's kind of the peak of color. It started in February 2012 and kind of peaked in August, September, and October.
I think the team did a very good job last year. It was a good quarter. I expect great every single quarter, and I have to look at it now and go, in hindsight, could we have built a better assortment commercially that could have allowed us to gain share and growth in other categories besides denim, that when you put it all together, could have produced a performance of better than a +1? My answer to that is yes. The merchant teams and design teams and marketing teams know that our expectations always are when you're up against that kind of very strong performance in denim last year, then what are we doing strategically on our assortment, and how are we building an assortment to be as commercially strong as possible to achieve better growth and better market share than the year before?
I've been here 25 quarters, and every quarter has its own unique circumstances. I've been here for two quarters where we were announcing an acquisition, whether that was Athleta or Intermix. I've been here in some quarters where we talked about we're going to go into a new country. An example of that was when we announced we're going into China for the first time. I've been here where we've talked about the fact that we had to make adjustments to the company's operating model in order to be successful. In order to get a 14% increase in earnings per share, we did manage the SG&A line without doing any long-term or midterm damage to the business, to our prospects, to our brands. This is the model we have.
When we can sense that maybe you see a little bit of a consumer slowdown, or in this case, a combination of the consumer not reacting the same way they did in the first half of the year, and us not building the kind of assortment that I hoped we could build, we were able to make the adjustments in our economic model to still produce the earnings we produced. I think that speaks to the experience of the management team, the commitment of us at Gap Inc. to be successful and to win and produce results that we expect of ourselves, that we'll make those adjustments. I do want to be clear on one point. This is very important to me. We will never make any reductions in a SG&A plan that damages the business short-term, midterm, or long-term.
We still had strong investments in the third quarter to deliver on our growth plan, to introduce omnichannel, to get the company ready next year for responsive supply chain, and just the beginning of what seamless inventory will be for us in 2015. Those don't get touched. That's all part of the company's long-term plan. This was just one of those quarters. Looking forward, we're just at the beginning of this very important quarter. It's not only important because it's Q4, it involves a big holiday season. It's important because it's the last quarter of the year. In order to maintain the momentum I talked about earlier on the comp side of the business, we like to finish every year strong. This is what this fourth quarter is about. I think the teams have done a great job getting ready for this holiday season.
We're as ready as we've ever been to compete in the marketplace. That's in Europe, in Japan, in China, in our franchise businesses, Athleta, Intermix, our three iconic brands. It's interesting, there's been a lot of conversation about late Thanksgiving and all the holiday shifts. Our view is there's always been these mini holidays within the larger context of the quarter. You get this run up before Thanksgiving, which is, again, this is true of the U.S. marketplace. You have the actual event of Black Friday and the two days that follow it. You have these two or three weeks after Thanksgiving. You have the week of Christmas, and what's become really important is the week after Christmas.
We, more than any year, have really planned and said, "Well, look, there's really five holidays inside the holiday." Let me just leave you with this one thought. Every year, all companies come into the holiday season with a pretty good list of what we're going to do differently to make sure that our business is better than the year before. That's a long list. None of us have enough time to go through it chapter and verse today. I just want to mention a couple of them to you. One is, on Tuesday this week, we launched Reserve in Store, which we were piloting in Chicago and San Francisco, into every single one of our Banana Republic stores and close to half of the Gap brand fleet.
Secondly, we've made gift cards a much bigger part of our business. There's been some great work done by all of our teams to make that really a driver of success for us from now to the end of the year. Lastly, we are very coordinated between our online and store business. The reason behind that is the structural change we announced last year, them looking at the brand across all channels. You'll notice they're much more coordinated. I think that's going to be good for us to make sure that we can come together with the marketing power and the promotional and event power behind those two channels to win the season. Thank you for your time. Let me now pass over to Sabrina.
Thank you, Glenn. Good afternoon, everyone. We're pleased that we continued to meet our goals of growing sales and increasing earnings per share in the third quarter. Our earnings per share were $0.72 versus $0.63 last year. This represents an increase of 14% on top of last year's 66% growth. Here are some additional highlights for the quarter. Net sales were up 3% with comparable sales up 1% on last year's 6% comp increase. We leveraged operating expenses by 230 basis points. Operating margin expanded by 100 basis points to 14.5%. We distributed nearly $900 million of cash in the quarter, including the repurchase of 20 million shares at an average price of $38.77. Turning to sales performance. Third quarter total sales were $3.98 billion.
For the quarter, the translation of foreign revenues into dollars negatively impacted our reported sales by $61 million, primarily due to the weakening of the JPY. On a constant currency basis, our revenues were up 5%. Total sales and comps by division are listed in our press release. Now turning to slide six. Gross margins declined 120 basis points to 40%. Merchandise margins were down 140 basis points, driven by our promotional activity in the quarter. This was partially offset by rent and occupancy leverage of 20 basis points. Gross profit for the quarter was about flat to last year at $1.59 billion. Regarding inventory, we're pleased that we finished Q3 with inventory dollars per store up 4%, in line with the guidance we provided at the beginning of the quarter. Moving to expenses.
We managed our expenses in a disciplined manner and leveraged operating expenses by 230 basis points. Total operating expenses declined by $60 million versus last year to about $1 billion. Marketing expenses were down $16 million to last year at $162 million, primarily due to lower spending at Gap and Old Navy. Delivering on our goals of sales growth and expense leverage resulted in net earnings of $337 million, up 9.4% to last year. Moving on to cash distribution. True to our commitment to distribute excess cash to shareholders, we repurchased 20 million shares in the quarter. Our ending share count was 449 million. Year to date, we've distributed over $1.1 billion, and we're pleased to have announced today a new $1 billion share repurchase authorization. Year to date, capital expenditures were $487 million, focused on our growth in China, Old Navy Japan, global outlets, and Athleta.
We ended the quarter with 3,160 company-operated stores. Square footage was up about 1% versus the third quarter of 2012. Store count and square footage by division are listed in our press release. Now I'd like to share our outlook for the remainder of the year. We are reaffirming our full year earnings per share guidance of $2.57-$2.65. The range encompasses a reasonable set of outcomes for a holiday season that we anticipate will remain promotional. As a reminder, at its midpoint, this guidance implies a growth rate of 12% for the full year on top of last year's 49% increase. This is even after absorbing the impacts of both foreign exchange and the loss of the 53rd week. The following full year guidance metrics remain unchanged. Operating margin, about 13%, square footage, up about 1%.
Regarding company-operated stores net of repositions, we plan to open about 160 and close about 80. Store openings are weighted toward Asia, while store closures are weighted toward Gap North America. We expect capital expenditures to be about $675 million and depreciation and amortization to be about $475 million. Full year effective tax rate guidance remains at about 39%. For the fourth quarter specifically, there are a few important call-outs. First, it's important to note that Chinese New Year shifts from February 10th last year to January 31st this year. The shift in timing will likely increase our in-transit inventory at the end of the fourth quarter. Therefore, we expect our inventories at the end of the quarter to be somewhat higher than the Q3 increase, though certainly still in the single digits. Second, regarding foreign exchange.
Keep in mind that our year-to-date sales have been negatively impacted by $162 million or an average of $54 million per quarter. We expect this translation impact to continue into the fourth quarter. Naturally, this currency depreciation also negatively impacts our earnings in addition to our sales. Finally, the 53rd week. As we've noted since the end of the first quarter, just as the first quarter benefited from the calendar shift, the fourth quarter is expected to be negatively impacted by more than the eight pennies that benefited Q1. This is because the volume of sales for holiday is larger than the volume during spring. As a result of having one less week and the calendar shift, it is unlikely that we will leverage expenses in the fourth quarter, especially rent and occupancy.
Additionally, driven by the loss of the 53rd week, we expect the spread between comp and total sales in the fourth quarter to be negative. Having explained the unique considerations around the fourth quarter, let me close by saying that we're pleased with our solid year-to-date performance. We've achieved top-line growth of 6% with comps up 3%, we've delivered year-to-date earnings per share growth of 29% on top of last year's 43%. As we look forward, we're focused on delivering solid performance in the fourth quarter across our brands while pursuing our long-term strategies. Thank you. Now I'll turn it back over to Katrina.
That concludes our prepared remarks. We'll now open up the call to questions. We'd appreciate limiting your questions to one per person.
Your first question will come from Edward Yruma with KeyBanc Capital Markets.
Hi. Thanks very much for taking my question. It seems like you pulled back a little bit on marketing in 3Q, and I know that you were doing television or were going to. How do we think about marketing expense in the fourth quarter, and I guess how much flexibility do you have based on how the holiday shapes up? Thank you.
Sure. Most of the marketing was just as planned, Ed. You're right, in the third quarter, once we decided not to do television in the fourth quarter, the production cost that would have gotten into the third quarter didn't occur. For the most part, that reduction was as planned. What I'll tell you to be helpful, we expect marketing spend overall for the full year to be probably flattish, implies it might tick up a little bit in the fourth quarter, overall, no dramatic change. As a reminder, because marketing is so important, we are holding sort of flattish, as I said, on a full year on top of 2012's very large investment in marketing of over $100 million.
Got it. Thanks so much.
Sure.
From Citi, we'll go to Oliver Chen.
Thanks a lot. Congratulations on all the great consistency. Our question is about the assortment and the opportunity for betterment there. Could you just clarify where you may see the most opportunities? The merchandise margin in the marketplace has been tough on everyone, given the promotional nature. Are we to expect a continuation of the down merchandise margin? If you could comment on how you see that proceeding, that'd be great.
Let me take the first part of that. What I was trying to say on the assortment in my opening comments was a little bit that there's uniqueness to every quarter. One of the unique attributes about Q3 for us was it was anniversarying some very strong positive performance by us on denim, especially in August and September, and the denim was really driven by the color trend that was going on in 2012. The criticism of myself and of our teams is that we knew that trend was coming. I think we tried to match indigo with treatments on indigo denim up against the color denim trend, when in hindsight, every now and then you're going to get a trend, especially in a category that's as strong as denim for Old Navy and for Gap.
We're trying to match that dollar for dollar, and our assortment is just not possible. I think I've told people before on the phone that over 12 months, indigo denim with any kind of treatments and whatever the trend is on indigo will beat, over 12 months, will beat a color trend. On any given month or any given quarter when the trend is as strong on color, it's tough to really match that. In hindsight, this is what we get paid to do and I get paid to do, is to make sure that the assortment opportunities outside of dominant categories like that, we make the right investments, put in the right product, market them accordingly so we can gain share across our total business and maybe take a slight pass for one given quarter on such a big category as denim.
With regard to the merch margins, we don't guide specifically to that. To be helpful, as I said in my remarks, we are assuming a continuation of the promotional environment. With regard to gross margin, combine that with the fact that it's unlikely that we're going to leverage rent and occupancy due to that lack of the sales in the 53rd week.
Sabrina, just as a follow-up, when we think about next year and inventory as a major theme, how should we think about the modeling in terms of all the opportunities you guys have with untrapping and other more efficient inventory management?
Yeah. We'll have more to say about that when we get into next year. Really, most of that starts to take hold not until the back half of next year and into 2015. More commentary on that next year, Oliver.
Thank you very much. Best regards for the holiday.
Thank you.
Ladies and gentlemen, as a reminder, please limit your questions to one per participant. Your next question comes from the line of Betty Chen with Mizuho Securities.
Oh, good afternoon, everyone. I was wondering, Glenn or Sabrina, certainly, I think we all know that it's been very promotional out there. How do you think it's impacted each of the brand differently, if any, and do you feel like given the learnings we've seen so far that they have sort of the right tactics going holiday? Related to that, I was wondering if you can comment on sort of the GapCash event and sort of any early learnings you can share with us regarding that. Thanks.
Here's what I'll say about it. I'll say about the promotional environment that I'm sure that there's been a lot of commentary on over the last week as people ahead of us have had their calls and spoken to investors and shareholders. My view is there's a little bit of fatigue out there when it comes to consumers. The question is, are we disappointed in the consumer sentiment or as we, I'm just being honest, as an industry, have we really not been that innovative in order to give the consumers a value proposition that doesn't look like wallpaper day in, day out? We've tried to break out of that, and I think we've done a good job at Gap Inc. I think we can do a better job going forward.
If the definition of winning is having a similar promotion on a similar category week in, week out, I think people who are going to do that, I think they're going to struggle going forward. There's a point where the consumer's looking for an event. They're looking for something exciting. At the end of the day, we're in the fashion business. Maybe my past life, just purely playing a discount or price card might have been effective, but not in this business. When I think about the fourth quarter, and again, I think our team, every single year since promotions became a little more prominent in the industry, have worked hard to become a little more innovative. You mentioned, Betty, GapCash. There's GapCash. Banana Republic are doing the Eight Days of Giving.
We've got L'Wren Scott coming out in a couple of weeks, a big launch partnership with Banana Republic. We've got Overnight Millionaire for Old Navy. That's going to start at 7:00 P.M. on Thursday. It's a little bit of public service announcement here. 7:00 P.M., Thanksgiving Day, $1 million. So Overnight Millionaire. We have Reserve in Store, which we launched on Tuesday. We're really working hard. This business is all about product, and it's about service. We're really trying to make sure that we don't become predictable. That's really an acronym you do not want to have stuck on your brand. We are trying to be a little more provocative, find different ways to express value. I think the team's done a good job. My belief is they've done a really much better job in the fourth quarter.
It is, at the end of the day, the job of the marketers to speak to customers in a way that doesn't cause them fatigue.
Glenn, related to that, can you share with us what your thoughts are so far regarding the GapCash event in the store?
It's a little early, Betty. It doesn't actually get. There's the earn period, which takes about 30 days, and we give customers a break, then there's the redemption period, and the redemption's not starting officially until the day after Cyber Monday. Not that we'd ever comment on it, I've been pleased with how Super Cash as a tool has worked for Old Navy. This is a different spin because Old Navy and Gap are different brands, at least we've learnt how to actually do that the first time around. Made some mistakes with Super Cash when it first was introduced a couple of years ago, that's true of any program. That's been incorporated in GapCash. I think their first time out, look, we have high expectations, we won't know much for another four weeks.
Again, we'll never give specifics, but I'm hoping it'll be, as I just finished saying, something that's different and something that's provocative and not predictable that can help Gap brand gain market share.
Great. Thank you so much, and best of luck for the holidays.
Just a reminder to all on the phone, if you could limit your questions to just one. Thank you. From Janney Capital Markets, we'll hear from Adrienne Yih.
Good afternoon, everybody, let me add my congratulations. My question is, again, on the highly promotional nature. Obviously, Target this morning had talked about this new test in the California market, I guess for this Black Friday, 40% off all apparel and accessories. It kind of begs the question, as an industry leader. Can you hear me?
Yes.
Yes. How can you sort of change the nature of the competitive deflationary pressure, generate that customer loyalty back to the brand that is not solely tied to price?
Well, I think I gave a little bit of that earlier when Betty had her question. Look, another part of this, Adrienne, is that one of the advantages we have is that we're not a one-dimensional business. In the malls, we have to compete for that business, hopefully using some of the tactics I said earlier to be able to speak to customers in a much more provocative way and not all relying on a discount. I don't know about this test, but just being a 40% off.
Yep
an easel on the outside of your door. I mean, anybody could do that. We're in malls. We have outlet stores. We have a very strong online business. We're in strip centers with Old Navy. We have an international business.
Yeah.
When it's all said and done, we said this about five or six years ago, that one of the reasons we entered into the strategy we did on multiple brands through multiple geographies into multiple channels, we didn't want all our eggs in one basket. Is there deflation in the apparel business? Well, if you look at NPD, they'd say no. Is it a business that has heavy inflation? The answer is also no. We are trying, and the best you can do when it's all said and done is have amazing brands.
Yeah.
If you own a store, like the company mentioned earlier, they own a store. If you own brands and you put marketing behind them, you create excitement about the brand, ultimately in our business, you create some passion about what that brand stands for, that's what's supposed to sustain you or working towards over a period of time where there may be some deflation.
Great. Thank you.
Next, we'll hear from Lorraine Hutchinson with Bank of America Merrill Lynch.
Thank you. Good afternoon. Glenn, you talked about not cutting anything that would damage the long term or short term for the brand on SG&A. What did you cut? Are some of those buckets available to offset the deleverage from the lower sales in the fourth quarter?
Well, Lorraine, I think you know us well enough. I may have said in my opening comments that one thing Sabrina and I did when we started working together about six years ago is we committed to ourselves, we would put together a new economic model. We would build an economic model that had flexibility to it. As I said earlier, every quarter has its own unique circumstances or nuances. Sabrina and I have really trusted our brand presidents. We give them a chance to actually be successful in the quarter, put their plan in place, and stick to the plan and execute it. But like anything in businesses, if you cannot adjust to that, then you are going to have a failed quarter or failed success in a full year performance.
What we have been doing with them is we give them a chance to really deliver on their plan. When we see that the plan may not be delivered, like in Q3, to the level we expected, we have a flexible model, we can make adjustments. I should say that last week, the clock started again. We now have a plan that we agreed on with them many months ago, and they are working their way through that plan right now that has the right balance of sales, gross margin dollars, and leveraging expenses to produce the earnings we expect. At the end of the day, let us take this from glass half full. At the end of the day, let us assume the sales were better than we expected. Assumption. Therefore, the margin is better than we expected.
Like it was for seven quarters before this recent quarter, then we can let them continue to plan or even some cases, maybe make some deeper investments to maintain the momentum. These are choices we have as a business, and what we like about it is we are not stuck, that we can make that all the way through the end of Thanksgiving into Cyber Monday, that run to Christmas, the run after Christmas. I think the brand presidents understand that. We trust them, that they are making the right decisions. If we see a business that looks a little weaker than we expected, then we know how to make the adjustments.
I would say, Lorraine, the only thing I would add is for the fourth quarter, you can certainly count on us to continue to be disciplined. As I mentioned in my remarks, given the sales from that extra week fall off, it is unlikely we leverage, especially on rent and occupancy. With regard to expenses, if we do get some leverage, it is likely to be very modest.
Thank you.
From BMO Capital, we'll hear from John Morris.
Thanks, to the team. Congratulations on doing well in such a tough environment. Glenn, I know you talked about the TV marketing already. I'm curious about the timing of the decision. It's relatively new, right? To pull back on the fourth quarter marketing, I'm just wondering your thoughts behind that why, and your thoughts about that as it relates maybe into next year as well. Thanks.
Well, John, it really wasn't a pullback. I think that if I did say this in the last quarter, what the intent behind it was that if the third quarter television investment for Gap was outstanding on a number of different metrics. We had the ability because we have television buy, we can always exercise or let go and open up to the market, Stephen Sunnucks and the team at Gap Global would have chosen to come out this holiday and put the money in place. I actually thought the television was quite good. We received a lot of positive comments, was especially strong on social media. As we looked at it, we just felt that we had a good plan in place. We had a better media mix, and the need for television, while a consideration, wasn't necessary.
If we look at next year, what I can tell you is that all of our businesses are constantly looking at their media mix. I can't think of a single company you guys are talking to who isn't doing the exact same thing. What that means with Old Navy is Old Navy is a strong television advertiser, but they're seriously looking going forward at their media mix. Gap is not a regular user from a medium perspective of television, but it's an option for them. I think I've said before, even if Banana Republic had such a great idea and TV was part of the mix that can make that idea come true and give voice to it and drive traffic and market share in gross margin dollars, we're not against it. It's not part of the repertoire today, but we're not against it.
When it's all said and done, I think that you can count on Old Navy to have the broadest of media mixes. Gap has flexibility to always consider an additional medium, which is television. We have a strategic plan for a year. We look at the medium mix, and then we make choices as we come into a quarter.
Very helpful. Good luck for holiday. Thanks.
Next, we'll go to Matt McClintock with Barclays.
Hi. Good afternoon. Glenn, you're expanding Reserve in Store, but only to half of the Gap. I was just wondering if you could provide some of your thoughts on how you think about the opportunity for Reserve in Store between Gap and Banana Republic. You earlier talked about gaining market share through innovative ways and methods. I was wondering, how do you think about Reserve in Store as one of those innovative methods as you look to the holiday season? Thank you.
It's a little soon to tell on the second part of your question. I know I've said before that to me, executed properly, I think it could be a bit of a game changer for us. We're going to get a really good read. The whole premise behind Reserve in Store was, let's test it before the holiday and let's learn, because if there ever was a time, the notion of at 12:00 at night, somebody's on their tablet or their desktop or their smartphone, going onto the Gap or Banana Republic site, seeing something they love, reserving it, getting a confirmation first thing in the morning, and then coming in, because again, it's a reservation. It's not pickup. Reservation is, we believe, most appropriate for our business.
Come in and hopefully our team can expand on their selection by adding different items and products to it, and then completing the purchase. People are time-starved this time of year. It's a unique service. It's only been broadly available in 650 stores since Tuesday morning, so it's a little early to tell. I really believe that if we can get a good read, execute it flawlessly, and get the marketing that tells customers a story I just told you, which is, we're open 24 hours. Don't think we're not. It's amazing how many people are actually placing orders after 10:00 P.M. and before 8:00 A.M. That's really the message this time of year. Place the order. We'll reserve it for you. It's sitting there. We'll tell you when we have it.
I think it could be a great foundational component of unique messaging in our category for those two brands, maybe even for Old Navy one day, definitely for Athleta, as we look at unique marketing ideas to try to drive our business, as I was saying to Betty earlier, that are not dependent on promotional activity that we think is inappropriate when you have brands like we have. Why 200 stores? The Gap team looked at it. They got great regional coverage. The Banana Republic team were the first to actually test it. They were the ones who were further along, so they were more comfortable going almost chain wide. I would be surprised if the Gap team didn't add more stores in the new year.
Thanks a lot, count on me being there at 7:00 P.M. on Thursday.
Next we'll hear from Lindsay Drucker Mann with Goldman Sachs.
Hi, good evening, everyone. I wanted to ask, Glenn, you talked about the fact that you, not to the detriment of your long-term investments, when you pulled back on some OpEx this quarter, you still were able to invest in a number of things, including responsive supply chain. I was just curious, can you give us some specifics on what areas you were investing in and what we should expect from responsive supply chain for next year?
Sure. I think what we were trying to communicate, there's certain investments and certain strategic plans the company has that are regardless of any given signs of ourselves or consumer weakness, we're just going to continue to stick with them because they're part of the company's long-range plan. In that bucket, you'd have investments like in China, Old Navy International, Athleta growth, some recent growth with Intermix, global outlet. There's a list of investments we continue to make. To your point, we went forward, whenever it was, sometime earlier this year and said, besides our growth initiatives, we have seamless inventory. That's just getting going now, but will not be delayed because of one single quarter. We are just getting ramped up now to make the investments in 2014 to get the benefit of a seamless inventory operating model in 2015.
Omnichannel that Matt just asked about. It would've been easy for Sabrina and I to cancel, delay Reserve in Store, but we'd never do that because that comes with an investment. It's a very important part. Of all the omnichannel plays we have, and I just met with the omnichannel team the other day, roadmap's in place. Really excited about some of the ideas they have for 2014. The last one is what we call responsive supply chain. Again, those don't come with a lot of investment. That's more of a process change than investments. From that perspective, we are continuing to push ahead. We've made some good progress. It's never enough for me. I would really like to see us go faster on that front, but the team is moving at a pace they're comfortable with.
As Sabrina said earlier, maybe a little teeny bit of benefit in the early part of 2014, but the majority of a responsive supply chain model we're going to operate will more be in the back half of 2014. Certainly you never hear from us or our presidents any reason to delay the company's top four strategic initiatives.
How specifically should we expect the supply chain to be more responsive in the back half then because of these investments?
I'd say it's multifaceted, we talked about. First and foremost, it started with fabric. We've done fabric consolidations. That, for the most part, is done. We are now completing fabric platforming. Then we have, don't get in too much details as probably other people want to call in. We have three other components which we've put out publicly, VMI, test and respond, and rapid response. Those are all ways for the supply chain we have today, and the decisions and assortment strategy be made much later in the process. When I was talking earlier about the assortment strategy, missed opportunity, as far as I'm concerned, when it came to denim in August and September of this year.
If we'd had in place an operating model that is based on what I just said, we could have made adjustments to the assortment strategy in early to mid-spring to correct as we looked at our assortments. You know what? We probably need to maybe adjust this slightly. We could have made those with a responsive supply chain. There's a long, long list, Lindsay, of all the benefits we're going to get. Number one is getting closer to the market. Secondly, is dealing directly with mills as opposed to vendors by having fabric platforming and being able to make decisions later in the process and keeping your powder dry. We are all set up to get some initial benefit from that in the back half of 2014. It's not a one-time win. It's something that just continues to evolve, and we continue to get better at.
Thanks very much.
Next, we'll go to Barbara Wyckoff with CLSA.
Hi, everybody. Couple questions about China. Could you talk about the year-to-date results of Gap in China? How are the stores comping? How many do you have at the end of third quarter, and how many of the 160 new stores will be Gap in China versus Old Navy?
Did you say 160?
You said 160 new stores and 80 closures.
Oh, sorry.
The 160 would be more international, and the closures would be more Gap.
Well, let Sabrina get to that. Here's what I can say about China. I was just there two weeks ago. Again, we feel very good. We're going to end this year with 82 stores, which will be, give or take, 10 outlet stores, and the remaining being Gap specialty stores. I was walking our first Old Navy, which is going to open on March 1st in Shanghai. That was under construction with the team. We'll be telling you in February how many Old Navys we're going to open in 2014. What you're looking at now is the expansion of the strategy from four specialty stores initially and an online site to now I'm saying end of the year at 82. Outlet now becomes part of the picture, and here comes Old Navy.
We were really excited recently with what is the Black Friday of China, which is 11/11. The big Tmall event, and we've been online in China now for over three years. That was just another example to us that the mix in that country of physical stores to online business is going to be much different than it is in the U.S. when the dust settles, say, five years from now. That's why we were so passionate on getting our online site open and making the big investments, as we were saying earlier to Lindsay, making investments behind our online site in China because we do believe the proportionality is going to be different in China, and we need to be ready for that. We feel good about it. Like I said, the team's great.
They're excited. They're making good decisions. We're looking forward to we'll announce in February how many stores we're going to have. Gap specialty, but that's going to continue. How many more outlets, that's going to continue. Give you an update on online and most importantly, an update on the launch of Old Navy.
Yeah. Within the opening number, Barbara, there's 35 of those openings are for Gap China. There's no Old Navy China this year. That's going to happen in 2014, we'll give you that number.
Okay.
There's 15-20 Old Navy Japan in the opening store counts as well.
Okay. Thank you so much.
Sure.
From Wells Fargo, we'll go to Paul Lejuez.
Hey, thanks, guys. Just looking at the fourth quarter, just wondering how you think about the comp drivers for each brand. Now that it seems like we're probably looking at lower AURs, just wondering how confident you feel, Glenn, that you can hit eight quarters in a row. Thanks.
I'll just start, Paul, by giving a little bit of color on Q3. Given that gross margin tick down, clearly our average unit retails were down. Our traffic, largely driven by that stronger dip in September, especially at the end of September, because traffic improved in October. Traffic was also negative for the quarter. The two levers that supported our positive comp were conversion and units per transaction. We're assuming the promotional environment continues into Q4, I would say that we'd love to see traffic stronger. Of course, we'll be working on that, and we will be doing everything we can to improve our AUR. Again, with the assumption that the promotional environment continues, I would say the two drivers will continue to be conversion and UPT.
Is that across all brands, Sabrina, or can you maybe separate each one?
I would say in general, yes. There's obviously going to be some differences, but in general, for the three big brands. Obviously, Athleta is in an entirely different camp given its size and it's a very different brand. The three other brands, I'd say generally, yes.
Part of this too, Paul, will be when the quarter is done Is what percent of our business did we actually do on Black Friday, and what percent of our business did we do from December 26th to, let's say, January 10th? We know we're going to do big business on Black Friday and Black Friday weekend. We know there's big business to be had on post-Christmas. Based on the sort of general theme that's been going on, can our product and branding and marketing messages that are less focused on discount, can they resonate enough to drive the traffic we need and the conversion side of the business, which lessens the dependency on those more discounted times of the quarter?
As I'm sure people have figured out, maybe a long time ago, maybe people spoke a lot less strategically about retail in general and maybe fashion apparel. Anybody else you're talking to in the last couple of years, you've really got to be thoughtful and strategic when it comes to your gross margin management and traffic management. Here we are, the weekend before Thanksgiving. That's a very important time to think through this first weekend. You have a run from Monday to Wednesday is a season within a season. Thursday now is its own day. Friday is its own day. Saturday and Sunday is a unique pairing. You have this run of two or three weeks before the weekend before Christmas. It's its own unique time of year. You have December 26th.
To say that we don't spend, I would probably say, maybe too much time overthinking and doing our analysis and talking to customers and trying to figure out trends is what we're spending more time than five years ago. We never spent this kind of time trying to really figure out day by day and weekend by weekend. If we figure it out right and make the right decisions, I think Sabrina's right. We'll probably have a quarter that has less pressure on AUR. That's to be determined still. We're in that first weekend of the run I just talked about. If we've planned it right and thought through it properly, hopefully it'll produce the results as Sabrina said, we're working towards, which is getting an improvement in our AUR, and that's what everybody here is trying to accomplish.
Great. Thanks, good luck.
Next, we'll hear from Brian Tunick with JPMorgan.
Great. Thanks. Good afternoon. I guess as we try to parse through the prior 6 quarters to this, there's been questions of how much the color bottom cycle in particular has been such a big driver, I guess, especially the Gap division. Just wondering if you guys have any comments you could share from an internal perspective of how sticky you think your market share gains might be going forward. Are we going to expect to see ongoing 30%-40% off the entire store into next year, if need be, to protect those market share wins? Thanks very much.
Yeah, Brian, what I was saying a few calls ago was that I thought we did actually a really good job in the first 8 months of the year when we were up against the anniversary of the trend you just referenced. I know I've said before that trend kind of peaked in September of October of LY. We've been through this assortment opportunity multiple times. I just think that's the miss we probably had. As for market share, given the fact that we had the performance we had from February till August, especially in those categories, I think we didn't only hold our market share, we built it. There have been some people recently that put out their numbers who are pretty dominant in the denim business. I would say that we've continued to gain share based on the performances we've seen.
Our own internal numbers and the external numbers we stare at would indicate that. While the anniversary has been a challenge, we've not only held our share but gained on top of what we were able to achieve in 2012.
Moving on from Topeka Capital Markets, we'll hear from Dorothy Lakner.
Thanks. Good afternoon, everyone. Just switching gears a minute. Just wanted to go back to Athleta. You have opened lots of stores this year, kind of getting up towards that 100-store mark, hopefully sometime next year. You've also made some adjustments to the assortments there. I'm just wondering if you could share with us anything you're learning as you've moved some of the assortment towards more, I guess, what I'd call street wear, in addition to the great performance wear that you're offering. How are you thinking about Athleta as you continue to grow the store base?
Good for you, Dorothy. That's actually a really good observation. My challenge with this all the time is not to swing it too quickly, but yes. I would say that part of what you've observed, which is absolutely correct, was driven as we opened our first stores in New York and realizing that maybe the Northern California aesthetic of Athleta was a little too much for New Yorkers and some other urban markets we're into. The challenge for us is not to give up on that. We bought the business. We love Athleta, and part of that is that it has a unique aesthetic, and it is what it is. It's in Northern California, and we can't just eradicate that. Finding a better balance is what you're observing right now. I'd say that's really worked out well for us.
I think the team, led by Art Peck and Nancy Green, have done a great job of opening up, let's say, the brand aperture a little bit and get people who maybe the previous aesthetic, which is not for everybody, were willing to accept it and maybe mix and match that with a wardrobe, but just buying exclusively that aesthetic wasn't something that was attractive to as large a customer base as we'd like. When you expand as many stores as we do also, the observation we had to make is if we want to have, you referenced 100 stores, if we want to have a business at that level or greater, we're going to have to get a bigger tent for customers. That's been happening now for about three months. I think the marketing has now followed with it, so has the website. There's more changes coming.
Nothing dramatic, just to keep broadening the brand's appeal, as you referenced. How do I feel about it? I feel great. I really think the team's done a really strong job of presenting the brand in a different way without moving too quickly, so far, the customer response has been very positive.
That's great. Those stores look terrific. Good luck for holiday.
Thank you.
From Sterne Agee, we'll hear from Ike Boruchow.
Hi, thanks for taking my question. I guess, Glenn, just a high-level question for you on sourcing. When we start to think about 2014 input costs, can you talk about wage inflation in areas like Malaysia, and how that could potentially spread to other countries in Asia, and just any high-level thought you have there would be great. Thanks.
Well, it's a little early to tell about one of the larger components of our costing, which is the raw materials. So far, cotton and oil are behaving decently well, I think we feel good about that, and the team that's working upstream. Part of it is, are the raw materials going to be at a place that allow us to hold our current costing or even better it? Too soon to tell, but I like the direction it has been in the last 3 months. As I was answering a question earlier, some of the changes in our supply chain strategies that have been initiated the last 6 months, which is working directly with mills and less with vendors, and consolidating fabrics and fabric platforming, that should also give us an opportunity to leverage that change with the vendor community. You're absolutely right on labor cost.
Some increases in Cambodia, in Vietnam, in Indonesia. You referenced Malaysia. We don't do a lot in Malaysia, Bangladesh. That's a smaller component of our total cost, but it's a component. That's been going on, and we're making the adjustments, and whether that's by taking more capacity at factories or having fewer vendors. We're doing everything we can to manage around it. The big win for us is the change in our supply chain. I think that's going to bring some benefits to us. The team's working on that, and something we can't control and we know how to manage one way or the other is if commodity costs behave, and so far, so good.
Thanks very much.
Our last question will come from the line of Richard Jaffe with Stifel.
Oh, thanks very much. Glenn, a question for you. As CEO, that is to say, professionally, what would you ask Santa for this year?
Well, I'm a very tough person to buy for. I will tell you that on a number of different fronts. If on a personal note, if everybody in the office here can have a very happy holiday and get a chance to relax after all the hard work they've done, I'd feel good about that. Of course, we always want to make sure that I've always had faith in the consumer. I'm a glass-half-full person. I just believe the consumer is, there's more tailwinds than there are headwinds, and I think they're gonna come out and buy, and if we execute properly, then I would consider that to be a very positive Christmas.
Okay. I was really thinking professionally, it's a kind thought for your workers and coworkers, and I share that. Happy holidays. Let's all get out there and shop early and shop hard. Thanks very much.
Thank you.
Thank you.
As a reminder, our earnings press release, which is available on gapinc.com, contains a full recap of our third quarter results, as well as the forward-looking guidance included in Sabrina's remarks. As always, the investor relations team will be available after the call for further questions. Thank you. Thank you. That does conclude our conference. You may now disconnect.