I would now like to introduce your host, Katrina O'Connell, Vice President of Investor Relations.
Good afternoon, everyone. Welcome to Gap Inc. Q4 2012 earnings conference call. For those of you participating in the webcast, please turn to slides 23. 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 of measures we are 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 ks 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 February 28, 2013, and 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, and welcome everybody to the company's 4th quarter earnings call. I want to talk a little bit about the Q4 and give you some color around it. I think it's important when you end a fiscal year for you to hear what I think were the accomplishments for Gap Inc. In 2012. So in the Q4, we were pleased with our sales, 5 comp, 10% total sales.
Yes, the 53rd week was in that. But at the end of the day, when you back that out, we had a market share gaining quarter. And that's what's important to me, not
only for us to have good execution to gain customers, but the
product in front of to have good execution to
gain customers, but the product in front
of customers that is right for each one of our brands, but to go out and actually gain market share. One of the areas that's worth highlighting is our online business
was up 28% and that
was a very good performance by as everybody knows a critical part of the company's long term growth strategy. We had a $0.73 in earnings per share and that was a 66% increase over the year before. So on the surface, those are very good looking numbers for Gap Inc. With that said, we believe there's a lot more business to be had for us in December. When I look at the business and dissect it and spend time with the teams after the holidays, we still have quite a bit of opportunity available to us and value to unlock between Thanksgiving and Christmas.
Now the consumer patterns are really shifting and there's big amount of business being done around Thanksgiving and Black Friday and a lot of business being done in the last 3 days before Christmas. We got to figure out the 3 weeks in between. Now we have an opportunity to do that because we have multiple brands, because we can play the online channel, the outlet channel, the specialty channel differently to make sure we capture as much business as possible and unlock as much earnings as we can possibly get in that 4 week period. The last thing I should mention about Q4 is the acquisition of Intermix. That's something we're just very pleased with.
We love that business. There's a lot of talented people at Intermix. We're going to help them when it comes to their integration strategy, what could be their long term growth. Early days, but we feel even better about the decision we made today than we did 6 weeks ago. Now let me turn to 2012.
And from my perspective, what were the key accomplishments for Gap Inc. In the last fiscal year? It starts for me and ends with product. I've been very pleased with our merchant teams, our design teams and how they brought product to life that's absolutely right on what the brand stands for, the customers they need to gain, the aesthetic and consistently doing that season after season. Part of that were the investments we made again that were targeted.
They were in key categories. Where can we make an investment that a customer is going to notice and it's done in a category that is so quintessentially associated with that brand that we know we can build a business from? And we added our creative advisor role, which was new for us to make sure that our teams were given every single chance and as much talent as they needed to be successful. We married that up with an investment in marketing. And the marketing investment was mostly in Gap brand.
It was mostly made domestically. And that was all about getting the brand back to relevance, getting people to see the incredible equity in this iconic American casual business. And the Be Bright campaign was launched 12 months ago. It's been a very good platform for the business. One of the key focuses and where some of the investment went for Gap brand was to get new customers in their stores and on online.
And the way they use social media, some of the unique relationships and partnerships that Gap had, I think was a big contributor to their performance in 2012. China continues to do very well for us. We opened up 30 stores in China in 2012. We brought the outlet business into China. So now in China, we have our specialty business, our online business that opened up day 1 when our stores opened and the outlet business.
What I've been really impressed with is the team we've built from basically nothing 2.5 years ago. We have an office in Shanghai of talented people, a mixture of people who know Gap, who decided to relocate to Shanghai and some incredible people that we've hired locally. That team is building a business for the future. China is a cornerstone of future growth for Gap Inc. Our awareness in China continues to grow.
Part of that is the stores. A big part is the marketing we're putting behind that business.
If you don't build a brand in China, you are not going
to make it too If you don't build a brand in China, you are not going to make it. Too many new entrants, too much competition. And if you put the right marketing and stand for something and differentiate yourself, you're going to have a long term successful profitable business. We put some new growth irons in the fire in 2012. We opened up our first Piperlime store in SoHo to try to find the right marriage between that online business, which is digital and the physical expression of Piperlime.
We launched e commerce in Japan across Gap brand and Banana Republic. And one of the biggest accomplishments of the year for us was taking Old Navy outside of its domestic domain where it's been in for almost 20 years and taking it on to the international stage by opening our first store up in Tokyo. And the team did an incredible job. The customer response has been great, because what's missing for so many customers in Tokyo is this family brand based on American aesthetic with a value proposition. And I think that combination has resonated very well and I'll talk about 2013 later on.
Let me give you the update on our existing growth initiatives and you all know them. Our franchise business went into 9 new countries, opened up 85 stores. Our outlet business that is now a global business had the most store openings they've had in the last 5 years. Our Athleta division added 25 brand new stores and our online business just continued to grow globally. So when you think about it, we're doing the right thing for customers.
We're bringing new customers into the Gap Inc. Portfolio and family of brands with Athleta. We're using our channels to provide access to our customers online, outlet and specialty. On the other side of the coin, moving these businesses so they become a bigger and bigger part of our total revenue is great for return on capital. So this is strategically the right balance between what's right for the customer and what's right completely restructured our business.
We felt very strongly the customer is changing. The customer is looking for a seamless experience. They see everything we do as one single brand. So in order to make sure that our structure and our strategies match up to where customers are and where customers That was such That was such an important change. That was a critical part, so we'll introduce speed into the company, looking at a single customer through one lens.
And what is the right way to get more share of wallet from that customer when you have all these different choices and one single team can do that for us. And here we find ourselves in the 1st month of Q1 of a brand new fiscal year. And we've been spending a lot of time talking to our teams about where's the customer today? Where's the economy? That's important for us, because now with the new global platform, we have choices.
Where do we think that the biggest potential is for us? And the consumer at the end of the day, we are looking at the consumer and saying, we have to continue to give her reasons to consumer and saying we have to continue to give her reasons to buy, more excitement. Just think of some examples last year. When we launched the Rockstar Jeans at Old Navy, that was provocative. That gave her a reason to buy.
When When Gap came on the fall with our marketing campaign called icons redefined, that gave her a reason to buy. If you're going to win in this environment, doing the same thing all over again is not a winning strategy. We have to bring more and more uniqueness, differentiation and excitement to the business. So beyond that, some big priorities for us as we look forward. 1 is the growth.
As we look at our company, we're looking at Old Navy Japan. Let's put 15 or 20 stores in there in 2013. Build on that one successful store. And then I'm asking the team led by Stephan Larson, where to from here? Not this year going forward.
We're going to answer that question this year. China, we're going to open up 35 stores in China in 2013. At the same time, we're going to ask ourselves the question, what's the next brand going in China? When? How are we going to put those into the China marketplace?
How is the team going to operate? That? We're going to have those answers done this year. The franchise business is going to add around 75 stores, building on a very good year last year, more global outlet growth, more online growth. And Athleta is going to add around 30 stores.
It's a step up from previous years. If you look at the company in the last 5 years, this is the most new square footage we've put in since 2007. As a matter of fact, we're in a gross square footage for the first time since 2007. And the driver of that is what I just took you through, but also this is the last year of our 5 year real estate plan. 5 year real estate plan was put forward in 2,008 to do what?
To cut back on domestic square footage through closures, consolidations and getting rid of square footage where we just did not need. This is the last year. So here we come now in 2013 with the most openings much more thoughtful. We're going to have less closures in 2014 as we complete the 5 year strategy this year. So I'm pretty excited as you can tell about what the future holds for us when it comes to new square footage.
And the other area of focus for me is omnichannel. You're going to hear a lot about that from a lot of other companies. Here's all I care about. Can we get a competitive advantage? There's probably 5 or 6 components to it that just everybody's going to get done over the next 3 years.
What are we going to do restructuring made in the fall and the ideas they're coming forward with, the talent they've brought in and how we're going to approach the marketplace, so the customer participates in the brand seamlessly. That's so important seamless experience. We have some really good ideas that are going to be launched in 2013, which we'll talk about down the road. We have to have this to win long term. Now those two key initiatives, the work on omnichannel and the step up in our growth and that sits on top of a foundation of steady growth with consistency in our product delivery, marketing, store execution, all those components that allow the foundation of the business to positively comp in 2013 as it did in 2012.
So with that said, we know that our customers have expectations of us and our shareholders have expectations of Gap Bank in 2013. Nobody puts more pressure on themselves than we do as a company. We really were proud of what we did in 2012. We know we can do more. We know we have to do more.
We know we have to make sure a lot of things I talk to you about today get executed flawlessly. We know where it starts with product and we know we have to be very good at some of the other initiatives and innovation we need to have in the business in order for us to win. So with that said, I look forward to giving you updates throughout the year on our performance and how we're moving forward in the strategic plan. Let me now hand it over to Sabrina to give you an update on our financial performance for 2012 and to provide you guidance for 2013. Sabrina?
Thank you, Glenn. Good afternoon, everyone. I'll begin today with a review of our Q4 and full year results and then provide an overview of our outlook for 2013. Please turn to slide 4. We are very pleased with both our Q4 and full year performance.
We achieved our stated 2012 objectives, namely increasing sales with healthy merchandise margins, prudently investing in our business and growing earnings share. Here are some highlights for the full year. Net sales grew 8% to $15,700,000,000 with comps up 5%. We invested in product, marketing and payroll, which drove successful results in North America. In addition, we made investments to support our strategy of expanding through new channels and geographies.
Even with these investments, we expanded our operating margin 2 50 basis points to 12.4%. We delivered earnings of over $1,100,000,000 and grew earnings per share nearly 50 percent to $2.33 And finally, we distributed $1,300,000,000 of cash to shareholders through share repurchases and dividends. Please turn to slide 5 for our earnings recap. In the 4th quarter, operating income was $602,000,000 up 230,000,000 dollars and net income was $351,000,000 up $133,000,000 4th quarter earnings per share increased 66% to $0.73 per share. Turning to slide 6, sales performance.
Driven by solid product acceptance, 4th quarter total sales were $4,700,000,000 up 10% including the 53rd week with comp sales up 5%. Full year total sales were up 8% to $15,700,000,000 and comparable sales were up 5% for the year. Total sales and comps by division are listed in our press release. Turning to slide 7, gross 7, gross profit. For the Q4, gross profit dollars grew by 26 percent to $1,800,000,000 and gross margin was up 480 basis points to 37.6%.
Our merchandise margins were up 370 basis points, driven by decreases in average unit costs. And rent and occupancy leveraged 110 basis points. For the full year, gross profit dollars grew by 17 percent to $6,200,000,000 and gross margin was up 320 basis points to 39.4%. Our merchandise margins were up 200 basis points driven by improved product acceptance, especially in the women's businesses across all of our brands. Rent and occupancy leveraged 120 basis points.
Turning to inventory on slide 8. Inventory dollars per store were up 5% at the end of the 4th quarter in line with our comp performance. Please turn to slide 9 for operating expenses. We noted throughout the year that we plan to invest more in our business during 2012 and highlighted that we would deleverage. In line with that framework for the Q4 total operating expenses were $1,200,000,000 up $141,000,000 from the prior year driven by store related expenses and marketing.
As a percent of sales, total operating expenses deleveraged by 70 basis points. For the full year, total operating expenses were 4,200,000,000 dollars up $393,000,000 from the prior year and deleveraged as a percent of sales by 60 basis points. Marketing expenses were $653,000,000 up $105,000,000 to last year. As a reminder, our incremental marketing investments for the year were focused on Gap brand and CRM. Please turn to slide 10 for capital expenditures and store count.
For the full year, capital expenditures were $659,000,000 With regard to company operated stores, for the full year, we opened 28 stores on a net basis and ended the year with 3,095 stores. Square footage was down 1% compared to Q4 2011 driven by downsizes in our Old Navy business and consolidation of our Gap store base in North America. Store count and square footage by division are listed in our press release. Regarding cash and share count on slide 11. For the full year, free cash flow was an inflow of $1,300,000,000 and we ended the year with about $1,500,000,000 in cash and short term investments.
2 noteworthy points regarding our use of cash during the year. First, you'll recall we repaid the remaining balance on our term loan in Q3 for $360,000,000 2nd, we acquired Intermix for about $130,000,000 in Q4. For the full year, we distributed 1,300,000,000 dollars through share repurchases and dividends, including $563,000,000 on share repurchases in the 4th quarter. We ended the year with 463,000,000 shares outstanding. And now I'd like to share our outlook for the coming year.
Please turn to slide 12. In 2013, we will use a balanced approach to deliver on our financial goals. Specifically, we'll focus on growing sales with healthy merchandise margins, managing our expenses in a disciplined manner and delivering operating margin expansion and earnings per share growth. And as always, we remain committed to returning excess cash to shareholders. With regards to growing sales with healthy merchandise margins, our objective is to deliver modest positive comps on a full year basis in our large existing base.
In addition to our comp base, we plan to drive increased revenue through our new brands, channels and geographies. For example Athleta, Gap China, Old Navy Japan, Franchise and Global Outlets. We remain committed to disciplined inventory management and expect inventory dollars per store at the end of Q1 to increase in the mid single digits on last year's 7% decrease. Our second priority is managing our expenses prudently. Assuming we achieve our goal of revenue growth, we would naturally expect total expense dollars to increase.
As a rate of sales, however, we expect operating expenses on a full year basis to leverage. Given our balanced approach to delivering shareholder value, expense leverage will be a component of achieving operating margin expansion. And that leads to our 3rd priority of operating margin expansion and earnings per share growth. We expect to grow operating margin from about 12% in 2012 to about 13% in 2013. We expect earnings per share for fiscal 2013 to be in the range of $2.52 to $2.60 Our guidance contemplates some of the impact of foreign currency headwinds, specifically the weakening yen.
As a reminder, we operate wholly owned stores in 8 countries and are therefore subject to the economic and translation impact of foreign currency movements. To be helpful, the average rate in 2012 for the yen was about 80. Current spot rate for the yen has weakened by about 15%, which means our yen based sales and earnings translate to fewer U. S. Dollars.
When we issue our 10 ks in a few weeks, we expect to report sales in Asia of about $1,300,000,000 the vast majority being yen based sales. Although contemplating currency fluctuation is not new to how we set our guidance, we're calling out the impact this year due to the rapidity and magnitude of the recent move of the yen versus the dollar, while other currencies have remained much more stable. Regarding returning excess cash to shareholders, as evidence of our commitment to this principle, over the past 3 years, we have repurchased about 240,000,000 shares for about 5 dollars per share. In addition to share repurchases, we're increasing our dividend for the 4th consecutive year. In 2013, we intend to increase our dividend 20% to $0.60 per share.
As a reminder, we also announced a new $1,000,000,000 share repurchase authorization in January. Please turn to slide 13 for some additional full year metrics. Regarding company operated stores, net of repositions, we plan to open about 160 and close about 80. Store openings are weighted toward Gap China, Old Navy Japan, Athleta and Global Outlets, while store closures are weighted toward Gap North America. As we continue to optimize our North America fleet and build on our strategy of expanding through new channels and geographies, we expect square footage to increase by about 1%.
This is the first time since 2 1,007 that we're growing our square footage. We expect capital expenditures to be about $675,000,000 and depreciation and amortization to be about $475,000,000 And finally, we expect our full year effective tax rate to be about 39%. In conclusion, we're pleased with how we executed against all of our 2012 objectives. As we enter 2013, we're focused on a balanced approach to achieving our financial goals and driving further value for our shareholders. Thank you.
And now I'll turn it over to Katrina.
Thanks, Sabrina. 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.
We'll take our first question from Betty Chen with Wedbush Securities.
I was wondering, Glenn, if you can talk a little bit about brand building. Certainly, it sounds like the team made a lot of effort and progress in 2012. If you can kind of run us through where each brand stands in your mind in terms of how much additional opportunities left both domestically and Where do you think they've sort of made progress in that front? And how does that relate into sort of what we should expect for marketing expenses in 2013? Thanks.
Betty, I'll answer the first part and then I'll hand it over to Sreed on the second part.
Betty, I'll answer the first part and then I'll hand it over to Spreet on the second part. There's 2 parts from our perspective when it comes to the reasons why we spend marketing at all. So there's always a fixed part of marketing inside of our budget, store signage, windows and then there's a variable component, which are choices we make that we expect a return from. I'd say there's no need for any marketing domestically on awareness, whereas in China most of our marketing and the tactics and the tools we're using are all about driving awareness. So in the U.
S. And let me just focus around Gap. I think we started to gain some confidence about 18 months ago on New York City and Creative Center, what the team was putting together, how we thought product was going to come to life in spring 2011. We brought a brand new CMO in who is going to be in charge of the globe. He developed a very good platform and that's the reason we decided to put some money almost exclusively in our domestic Gap business.
While awareness has really not moved in I don't know how far back, but certainly since I've been here, the issue was about relevance and building equity and being much more current to the customers that we were targeting our domestic business. So from my scorecard, there's no such thing as the perfect outcome when it came to the marketing being invested. But we felt good with what the Gap team did. We felt it was again the platform was authentic, was appropriate for the brand. I think as I said in my opening comments, the choice of media was also I think smartly done, finding the right mix.
Not everybody should run towards social media. Some of those tools don't really have a great return right now, but there was a great balance in how the team approached it. And in China, which I spent a lot of time in, I'd say the awareness, I've been very impressed. We have in China a balance between the global marketing that comes out of New York, it gets used by the team in China and we have a unique agency we use in China to speak and to augment the message and to build the brand, especially when you're opening stores as we did last year in 5 new markets. So you can never assume that because we know when our awareness is coming in and that we choose different marketing content to go into these new markets we're going into and make sure people know, A, we're American, what does Gap stand for and why you should embrace the brand.
These are stories and marketing messaging has nothing to do with the value proposition. It has everything to do with the brand as I said at the opening. That's what long term success as far as we're concerned in China is going to look like. It's all about brand building. So we actually again felt good in 2012.
Was it perfect? No. Are we encouraged by the progress on the scores we look at? Yes. And we're going to continue to spend some marketing in 2013, but obviously nowhere near the step up we talked about in 2012.
Yes. And just to add to that, we don't specifically guide to marketing spend and we do that purposefully because we like to keep flexibility throughout the year as to monitoring the marketing effectiveness and actually making decisions about how much we want to invest given the business environment. So not a lot to say on the full year. To be helpful in the Q1, what I'll tell you is we have no plans to cut marketing expense versus last year for the Q1.
Thank you. Very helpful and best of luck.
We will take our next question from Kimberly Greenberger with Morgan Stanley.
Thank you so much. Glenn, I was wondering, if you could just talk about how you manage through the balancing the need to improve product execution and come up with some of those big ideas that you were talking about on the merchandising side. How do you sort of balance that while managing the risk in the business? And what sort of management tools do the merchants and the designers have at their disposal to manage that as well? Thanks.
Well, I think you know that our business is not based on perfection, it's based on precision, it's based on history, it's based on talent. They trust me, we have more than enough tools, which I'm not going to take you through Kimberly. But we have more than enough tools that the team can measure in hindsight, in market to get a sense of the decisions that we're making. Most important thing for me that the team has developed over the last couple of years, which we never had before, was to get a very early read at the beginning of the season from product that goes online, which tends to go on first before our product gets in the store. And we used to look at that result and use it more to cheer the accomplishments we had in that given season.
In the last couple of years, we use it to read very quickly what is what are we learning from that online? And how do we affect the upcoming season or how do we affect product in that season that's going to last longer than 12 weeks. So and this is not again this is not a revolutionary move for us, but our ability to us for us to chase into good ideas and to make sure the merchants, because the design team has done their job now, the merchants and the inventory management team and the sourcing team and the supply chain team are working in tandem. We've redesigned that whole process whereby the minute the REIT comes out and we see an opportunity, we can move on that very quickly, which really accomplishes one of the goals that Sreed and I've been working on since we started together, which was to reduce some of the volatility in the business. So I'd say that is the most important thing that I've seen.
Now to I'd say bigger ideas, I think that is a risk reducing strategy because we've been tightening up our assortment slowly and thoughtfully across all our brands for the last couple of years. We're never going to become just a straight item business. Collections matter, wardrobeing matters. But looking at the total assortment, I think the team has recognized that in some cases in categories that matter to us less is more. And I think that does reduce the risk.
I mean I've always internally said to our inventory management team even though I could be their biggest critic, when I defend them it's like it's very difficult to do the job if somebody is buying 24 of something when the customer only really wants 12 or 15. And you can have a huge big only really wants 12 or 15. And you can have a huge big idea on 12 or 15 colors of a skimmer bottom that launches in the spring. And that can still be a very big event, a big idea, can drive traffic and be brand right and create some excitement around the business. And the incremental 8 or 10 colors really don't drive any gross margin dollars for the business.
So in some ways the focus that each one of our brands is taking to different levels across different categories, I think, provides a little bit of de risking of the assortment. That's very helpful. Thanks so much. We'll take
our next
question from Janet Kloppenburg with JJK Research.
Good afternoon and congratulations everyone. A great year.
Thank you.
I had a question. I'm excited about your announced expansion plans and about the fact that your store closing program is going to conclude this year, at least that's my understanding. And I'm wondering then if we should look for I think we should look for the differentiating point between sales and total sales and comps to begin to widen. And I'm wondering if in fiscal 2014, if we could look for that differential to become even broader as the store closing program becomes much smaller, just so that we can model out our sales? And if you could touch on your opportunity for AUC opportunity this year that would be helpful as well.
Thank you.
Well, I would say Janet that that's certainly directionally correct. We've been working on the total growth of the business and it starts with a very strong base and that's what's most important to us. That's where our volume is. So let's call that domestic stores within the domestic brands including some Europe, including Japan that make up our comp pool. So this year having done a 5 comp which the business felt good about, I think that was not only gained market share from a comp perspective, but I think that's sort of the health of the business.
Now we have one more what I'd say big year, which is 2013. There's always going to be in a fleet of 32 to 3,300 stores. I'm just throwing a number out. There's always going to be 30, 40, 50 stores that you got to reposition or close, because the consumer is going to dictate that. But at the end of the day our massive change and it's really significant what we've done in the last 8 years sorry last 5 years starting 2,000 8 with one more year to go.
But what that's going to help is that our spread, which is what you're referring to the delta between our comp store sales and our total store sales, there's been a drag on that spread with the fairly sizable number of closures we've had inside the business mostly a Gap brand, but there's been some sprinkled across different parts of the world as well. But I think it is one of our goals. It's not the most important goal in the business, but we look at some of our global competitors in 2012 who also had a 5 comp and in some cases they had a double digit total sales. So do we think this year's number which was 3, but in fairness was helped by the 53rd week, Do we think that number should widen over time as the real estate program comes to an end? Do we get to just normalized amount of closing and consolidations?
And then the new store program picked up. Now we have 6 brands to choose from. Obviously, the first three matter the most. I think that's absolutely a goal. And one question that I answered at the last call was what I'm most excited about that with the new economic model that Sperry and I together is that those incremental stores come at a much better contribution to our operating margin than the last time we went through this where we were putting the 3rd or 4th store in the United States in a market that we've since had to go and close that store where the market only dictated 2 stores.
So now as you start adding Athleta that's all pure raw new contribution and I think we'll be good to operating margin over time. Same with Athleta, same with our franchise business and same with our outlet business. So those are all great that incremental dollar hits our P and L in a way that's much more accretive to the overall business over time than it would have been the last time we tried to grow our fleet, which was call it 2,000 and 2 to 2,007.
Yes. The only thing I'd add to what Glenn said is, that's all absolutely true sort of assuming currencies hold constant. So for example, in 2013, the point we were trying to make is obviously that spread between comp because comp is FX neutral. The spread between comp and total sales will be impacted by the foreign currency headwind in Japan. So that's just something to watch.
And then with regard to the AUC opportunity, I would say for 2013 Janet, I mean Q1 is the last quarter where in 2012 we were still facing headwinds. So we have a little bit benefit there in Q1. After that, I would say it's sort of normalized. It becomes sort of a non issue. And we're just sort of going to manage through in without the big swings up or the big swings down that we had in 2011 and 2012.
Thanks. Best of luck.
We'll go next to John Morris with BMO Capital Markets.
Thanks. My congratulations as well on a great year. Glenn, can you talk a little bit about the progress that you're making at Old Navy under the new team. What can customers expect to see differently this year? Because I think we'll see more from the New World team.
What will they expect to see differently compared to the Old Navy? How will the point of view in terms of the product etcetera evolve?
Well, I think the first thing John that's worth noting is that, Stefan has been here just under 6 months. And when we brought him in, it's because he believed in the brand and most importantly, the brand positioning, which was a non negotiable and the customers that Old Navy goes after, mostly that it's family brand. And we didn't want to have to revisit the notion that people can come in and put their own impression on the brand. The brand is what it is. Stephane has come in to improve it and evolve the brand.
And I would say what customers are going to see is even before Stephane was involved, the team that was there previously, I'm willing to say that they were making improvements in this Q1 in terms of product assortment. That was better than the quarter before in 2012. Now it's our job to translate that into greater sales and greater earnings, but they were already making improvements. I'd say he's going to have 2 impacts that should be noticeable to I think he's been working vigorously with the team on the assortment. And a little less like I was saying to Kimberly, a little less about tightening it up, although I'm sure that's going to be one of the outcomes.
I'd say that he is very big on building dominant categories. I'd say that he is very big on building dominant categories. I think he's helping with the fashion part of the business that is right for Old Navy, because this is not a fast fashion business, but making sure we get credit for the fashion that's in Old Navy, because at the end of the day what we provide is everyday fashion essentials to the family. And I think he's really driving that point home and he's bringing some discipline into the assortment planning and that's something he's very skilled at. The other side is that we're very excited this week that Ivan Wickstead joined us who's our new CMO.
And I don't think his impact will be felt immediately, but we brought him in given we brought him in given the incredible track record and experience he's had. And I think our customers will start to enjoy his handprint on the marketing messaging in the business in fall and holiday. And I've just been very happy with how he's come into the team, working with our merchant team and worked with the design team and all under Stephane. So Stephane didn't come in to turn the brand upside down. He came in to move the brand at a pace that I'm comfortable with.
But let there be no doubt, he's come in to improve the business. That is what he's asked to do.
Glenn, are you close to releasing some of the marketing dollars for Old Navy as well? I know you were thinking about that as recently as the previous quarter.
They've got all the marketing dollars any brand would ever need.
Great. Thanks very much.
Thank you.
We will go next to Lorraine Hutchinson with Bank of America.
Thank you. Good afternoon. The SG and A
has been very tightly managed for years. I know you spent a little bit in 2012, but as we look out over the longer term, are there any big investments that we should be thinking about whether it's e commerce or omnichannel or any of the other new programs or plans that you're expecting?
Yes. I mean, we're focused just on our 2013 guidance right now, Lorraine, and we can talk probably more about the longer term at Analyst Day. But I would say that we're being very measured about the pace of our investments. So you have observed that we've raised capital spend from probably an average of $475,000,000 $500,000,000 per year up to we spend over $650,000,000 in $12,000,000 We just guided to $675,000,000 So we are definitely focused on the long term and in propelling the long term growth and in making the right investments and putting the dollar behind that. But beyond what we've guided to, there's nothing radical that we intend to shift.
Within those dollars we've guided to, we feel really comfortable that we've appropriated enough to those strategically important projects like Omnichannel, like Gap China, like Old Navy Japan.
I think we're learning and teaching the business very well that in some cases there's a lot of initiatives or variable expense we're using in different areas of business that we either can't afford or is not necessary anymore. So brick in brick out in terms of state of mind is something that's very important in our business. And also, Sabrina mentioned China. For us to have a really long term viable business in China, there's some money we do have to invest, whether it's in people or whether it's in marketing. And we're challenging the teams internally especially the new 3 global presidents to look at their portfolio because we're going to hold them to a certain level of return and expectations on return on sales and return on capital.
So I think what I like about the new structure, it gives them a chance to look at where are the most the best opportunities globally where they should be investing their time and their energy and their capital to get the highest return. But we will always have new initiatives. We're not innovating and bringing new initiatives forward. The company is just going to go backwards. So we're pushing the team really hard on both fronts, but we're telling them very clearly as they work the one side of the growth story, they have to go back into their P and L aggressively and carve out money that's no longer needed.
And it's ours not getting a return. And that's how we're trying to that's how the 2 of us are trying to manage the business.
Thank you.
We'll go next to Adrienne Tennant with Janney Capital Markets.
Good afternoon. Let me add my congratulations for the year. Glenn, can you talk about the DTC opportunity? Obviously, it looks like it's about 12% for 2012. Sort of philosophically, how do you think that that's evolving across the sector?
How aggressively do you want to grow that piece of the business as a percent of sales? And do you have any targets in mind for us? Thank you.
Well, we don't put out targets. We certainly have some numbers internally. What I would say is I would sort of take it up a notch and say if we just look at the customer first, where we're moving and have moved a little bit in 2012, we'll take a bigger step in 2013 is just this notion of easy buy anywhere. And at the end of the day, to be quite honest with you, I don't care where that unit goes. The unit is going to go where we can where the customer wants it and we can get the highest return on that one unit.
That's online, if that's specialty, if that's international. And I think that our online business is obviously growing. That's a channel of choice. We've been working very hard to make sure that our website is attractive, that it's fast and that our delivery time to the consumer that we over exceed their expectations. So look at the end what's going to happen here is that the customer will eventually dictate whether 12 goes to 15, whether 12 goes to 18, where it settles out.
We're not going to stop it. We're not going to put any constraints on it. But as we move and make a big move in 2013 to have really a seamless approach to this, because what's going to happen at one point, my view is that we don't want to get anybody should be thinking about getting credit for the sale. And if you think of 2012 prior to the restructuring, we were set up that somebody owned the P and L online, somebody owned it in outlet, somebody owned it in specialty domestic and somebody owned it in international. It's 4 different P and L owners.
And they had agendas that ran through Sabrina and myself and we were in charge of coordinating those agendas and making sure we're doing the right thing for the company and the right thing for customers. Now you have 3 global brand presence. And their job is to say that I have a customer who chooses to shop in 3 different channels across multiple countries. How do I maximize that as best as I can? Can you take that kind of approach and think of something as simple as order online reserve in the store, it doesn't matter whose P and L that goes under, it's going to go under the GAAP global P and L.
And I think that the teams now are working much better together once we broke down the natural barriers, because I was a big believer in the previous structure we had, of course. And now I'm a bigger believer in the go forward structure that it just takes everything out of the way. And we always try to do the right thing. And that means feeding more inventory into online, we're going to do that. If that means feed into another country, we're going to do that.
But the key thing here is that it's just going to become more and more seamless. So we're going to let it go as high as it can. And as I said in my earlier comments, any unit that goes through purely in our online channel has a better return on sales and of course a better return on capital than anything on our stores. And now that we have a reset real estate, we were thoughtful in 2,008. We didn't anticipate exactly where the online business or the outlet business was going to be, but we were thoughtful, we don't need this number of stores.
We certainly don't need this size of store. And with the reengineered fleet we have in place, now I think we can make sure we move that inventory and satisfy customers, because access and convenience is becoming that much more important. Because access and convenience is becoming that much more important. And I think with our fleet and strong online site, I think we can meet the customer demand.
Great. Thank you very much. Best of luck.
We'll go next to Brian Tunick with JPMorgan.
Thanks. I'll hand my congrats as well. I guess maybe for Glenn, it seems like the Gap North America brand sales are 30% smaller than where you peaked a couple of years ago. And I guess the assumption is much of that has been a decline in women's market share. So we were curious how you rank maybe which categories Gap North America on the women's side has the biggest opportunity to regain share and move the needle over the next year or 2?
Thanks very much.
I'd say Brian without getting into the category strategies where you are correct is that our kids and baby share is larger in that universe than our adult share. And as we told, I think investors a couple of years ago, it sort of builds on the issue of why did we reengineer our real estate. One of it was because there was a time where we had 450 stand alone baby store kids and baby stores. And we really strategically thought that if there were customers that we did not we're not able to attract or satisfy and make them loyal to Gap brand 5 years ago as their lives evolve, how do we get them engaged again in the adult business? And one way to do that is the cross shopping that exists of a 12,000 square foot Gap store, where you can pass through between kids and baby and adult.
I think now that real estate is almost completely done that's going to be a big opportunity for Steven Sonex and his team. And much easier to use the strength of kids and baby and the market share and the natural draw to get of kids and baby and the market share and the natural draw to get some in this case women shopping in the adult section. There are key categories. It's not nothing's going to change in terms of the strategies and I'm not here to give out where we on equal to our total share in adult and where we above and where we below. But at the end of the day, this is a business that is grounded 1st and foremost in denim, in the adult business.
And our team in LA has done a great job. I think we're seeing the results of that again this spring with some of the work they've done. And that's there's probably 3 or 4 adult categories that are really important. That'd be number 1. And the team is very focused on how do we make sure we continue to gain share, current and relevant in the denim business.
And that's where I know the merchants and designers are putting most of their energy.
We'll go next to Oliver Chen with Citigroup.
Hi, congratulations. In terms of some external factors, could you brief us on the environment for product cost inflation? And also payroll taxes, do you think that certain of your banners will be more impacted than others? And what are kind of the competitive proactive stance that you can take in light
of that? And if I
could just ask a modeling question. Should we be more encouraged on the upside from the SG and A margin or the GM as we think about your op margin expansion guidance? Thank you.
Sure. Let me try and hit those three topics really quickly. So on the average unit cost front, as I said, Q1 is pretty much the last quarter that we get tailwinds because we were still facing increases, although nothing like the back half of twenty eleven. We were still facing increases in AUC in the Q1 of 2012. After the Q1, it really moderates and there's really no significant story around average unit cost.
So that will just be managed in its normal way and we'll manage through our mix and making select decisions
in
that. With regard to the payroll tax, it's really hard to split out the impact of any of these moves. But I think it's fair to say that our consumers now after so many years of a tough economy are sort of getting probably thicker skinned about any of these moves in particular. I think there's certainly some that are impacted more directly than others. But overall, can we claim a large direct impact of that?
I would say not overall. Obviously, if there's going to be an impact, our customers at Old Navy are going to be more sensitive to it than the others. And then finally, with regard to how we're approaching our year and I'll interpret your question by saying how do we get to operating margin expansion, Oliver. I would say we want to be very balanced about that. So we know that 2012 was unique because we could invest so much given that we were getting the benefit on merch margins not just from great product but also from average unit cost.
2013, we're going to use all of our levers. The 3 big ones of course are expense leverage, rent and occupancy leverage and merchandise margins and we tend to approach those in a very balanced manner.
Thank you. Best regards for the year.
Thank you.
We'll go next to Jennifer Davis with Lazard Capital Markets.
Hi. Let me add my congratulations on a great year. My question is really on gross margins. At the end of 2011, merchandise margins were down, I think, 4.40 basis points from 2,009 levels. This year, you recovered 200 basis points, so you're still about 2.40 basis points below peak.
And I would argue that the merchandise is significantly better now than it was in 2,009. So my question is, first, can you give us some sense of your full price or kind of planned promotional selling now versus 2,009? And then secondly, have you seen any benefits yet from the changes you've made in your sourcing structure? And then I'll try to throw one more in. And that kind of leads to the real question of, is there any reason why gross margins can't exceed prior peak levels?
It seems like there's more room with merchandise margins. And with the rationalization of the store base, you should get some more buying and occupancy leverage, not to mention the fact that international and direct are becoming a bigger part of the mix. Yes.
I think I understand your question. So let me try and hit that, Jennifer. So I think one of the important things to remember is that 2,009 for GAAP was a very unique environment in terms of costing. So the underlying cotton was certainly lower in 2,009 than it was in 2012 and then we expect it to be in 2013. So you've got an underlying commodity that's lower.
You have labor that was certainly lower in 2,009 than we certainly expect it to be now with labor pressures in Asia in 2013. So you had a very different costing environment for certain. I'd also point out in 2,009 despite our high gross margin rate, we were negative comping. So obviously, it is important for us to balance delivering a very healthy rate, which we are focused on with driving healthy comps and gross margin dollars. Now that all said, we do have levers and we are focused on delivering healthy gross margins.
And as you said, 1st and foremost with positive comp performance, we feel confident we'll leverage rent and occupancy. So that's a lever. And then regarding our merchandise margins with all the effort we've put against delivering strong product assortments, we have opportunities to move the needle in more rig selling. Certainly, still promotions, we'd love to draw back a little either in frequency or depth. And then markdowns also with better assortments, we might have an opportunity there to not go as deep on the markdown itself.
So we are focused on it, but very different than 2,009.
Great. Thanks and best of luck.
And we have time for one more question. Our final question comes from the line of Richard Jaffe with Stifel Nicolaus.
Thanks very much guys. And on a I guess farther ranging topic, sourcing, you guys have undertaken a dramatic change in your sourcing policies and practices trying to enhance speed to market, obviously to manage the vagaries in the marketplace cotton last year. I'm wondering how this multiyear initiative is going? Where you stand today? And what kind of promise is in the future?
Look, I would say we're probably in the 3rd or 4th inning. And the big driver Richard, the unlock for us is we may have mentioned this in past calls. For the longest period of time, we were very focused on our vendors and some of the stuff Sabrina was just referencing when our margin rate was pretty high in 2,009. That was when we were at the peak of the recession where we were making tough choices in our business. And the choices we made back then was to really focus and negotiate and use the leverage of the company to get what is known as our cut and make cost down, the actual making of the garment.
And that was a big focus of the business. As speed came in and speed became more important as I was talking earlier about chasing or rapid response or just actually the whole fast pipeline, which is putting new styles to work inside of a season. What the team and the new structure turned to is really fabric platforming and working upstream with our mills. So for the longest period of time, we'd work directly with vendors that was 99% of our relationships. And now we have a much stronger relationships with mills and fabric 1st and foremost.
And the way we again, more in the 3rd or 4th inning, but the way we've got our merchants and designers to understand it is if you want speed and you understand the gross margin upside of and the customer satisfaction that comes with that, the only way to be able to do that is have fabric that is ready to go. So just one example. Last year, we had a very good year. When somebody has asked about categories earlier in denim and Old Navy, one of the categories there was something we introduced called the Rockstar Jeans. And the Rockstar Jeans is a fabric that we developed.
We platformed it and then the team in sourcing goes and negotiates as many years out to get as low a cost as possible. And it's not colored. And all the team has to do is make sure that we're giving in the moment daily information to the vendors to make sure we're getting the right color and the right quantity to come in and fill the pipeline. We weren't able to do that 2 or 3 years ago. I think that was I might have said this 2 or 3 years ago on a call.
That was as much cultural as anything else. And as the culture has changed and evolved, I think now people are appreciating that we have to work directly with mills, work aggressively, narrow the number of fabrics we have because a fabric can be treated in so many different ways. So less fabrics, work with the mills directly, have them available there as a platform opportunity, create a toolbox of fabrics and therefore really push the speed part. Because while I'm happy to get gross margin dollars both ways, which is lowering our cost and driving more cost sales at REG and getting more dollars coming through on the AUR side, the real benefit of speed is AUR. And that's why I think the team can hopefully down the road get the benefit of both, which is managing our average unit cost through the fabric platforming, but more importantly putting more and more of our units on a faster pipeline, which all three brands now have and drive a higher cost sales at REG.
Glenn, just one follow on question. Are you making a financial commitment to the mills for fabric? Or is it more of an understanding a handshake if you will?
Yes. We don't get into the details of it, but I think let's just put it this way that mills understand that they have so much capacity and they look for companies to obviously eat up that capacity. So we work with our mills more than we have before to make sure there's so many yards that we need of fabric. And I think that we've built really good relationships. A lot of the new team members we brought in know that side of the business very well.
As a matter of fact, one senior person came from that business. And it's just it's what some other companies have done. I think we're trying to not only catch up, but then eventually go past them in instituting this new process in the business.
Great. Thanks very much.
Thank you. 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 at gapinc.com contains a full recap of our Q4 results as well as the forward looking guidance included in Sabrina's remarks. And as always, the Investor Relations team will be available after the call for further questions.
Thank you.
And this does conclude today's conference. We thank you for your participation.