I would now like to introduce your host, Mark Webb, Vice President of Investor Relations.
Good afternoon, everyone. Welcome to Gap Inc. 2nd quarter 20 10 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, including those identified in today's earnings press release, which is available on gapinc.com, as well as other statements that express our expectations, anticipations, beliefs, estimates, intentions, plans and forecasts.
Because these forward looking statements involve risks and uncertainties, there are important factors that could cause our actual results to differ materially from those in the forward looking statements. Information regarding factors that could cause results to differ can be found in our annual report on Form 10 ks for the fiscal year ended January 30, 2010. Investors should also consult our quarterly report on Form 10 Q for the quarter ended May 1, 2010, and today's press release. Future economic and industry trends that could potentially impact net sales and profitability are difficult to predict. These forward looking statements are based on information as of August 19, 2010, and we assume no obligation to publicly update or revise our forward looking statements, even if experience or future changes make it clear that any projected results expressed or implied therein will not be realized.
This presentation includes the non generally accepted accounting principle measure of free cash flow, which under SEC Regulation G, we are required to reconcile with GAAP. We are required to reconcile with GAAP. The reconciliation of this measure to the GAAP financial measure is included in today's earnings press release, which is available on gapinc.com. Joining us on the call today are Chairman and CEO, Glenn Murphy and Executive Vice President and CFO, Sabrina Simmons. Now, I'll turn the call over to Glenn.
Thank you, Mark, and good afternoon, everybody. Before I hand it over to Sabrina, let me give you some of my thoughts on Q2. Overall, I would characterize the second quarter for Gap as a decent quarter. We were able to achieve $0.36 in EPS, which was $0.03 above last year. We were able to leverage the operating margin line in the business by 40 basis points over last year, and we did all of that against the challenging backdrop.
Now with that said, I need to say that I was disappointed in our inability to generate the sales that we had expected to generate in the Q2. Because of that, we've certainly spent a lot of time over the last 4 to 6 weeks meeting with the brand presidents and their teams to make sure where necessary, we took course corrective action coming into the back half of the year. There was a heightened level of intensity on those meetings. And we've spent a lot of time talking about traffic and traffic generating ideas, our marketing initiatives in the back half, inventory management in the back half, how do we continue to innovate and differentiate ourselves. And most importantly, we talked about key product initiatives we have coming up and that's where I left a lot of those meetings to be quite honest and invigorated.
I really like what I'm seeing from those teams, from the merchant teams, from the design teams, what they're doing on product in the back half, how we're actually taking our brand proposition to an improved level. So there's 2 intangibles in the back half of the year. First intangible is what will the macro climate be exactly in the second half, which is out of our control. What is in our control is our ability to execute. This team has executed at a very high level over the last 12 quarters.
Now it's up to us to take these corrective measures from Q2, put them into place and execute into the second half. Let me now give you my thoughts on each one of the brands. Banana Republic had a 3 comp in Q2, and that's the 2nd quarter in a row we've seen nice positive comps from that team. As I look what transpired in Q2, one of the big changes that we've been talking about from last year is they've really changed their wearing occasions and I'm seeing a much more appealing offering when it comes to going out and to casual dress attire, which is important to Banana Republic. Big improvement in
accessories, which we feel good
about as we look towards the back half. We improvement in accessories, which we feel good about as we look towards the back half. Really like the marketing that came out this week. Hopefully, people saw it life at work, very appropriate for Banana Republic showing the versatility of the products and the key categories in which they're pushing towards. So all in all, good performance from Banana Republic look forward to even more improvements in the second half of the year.
Let me now turn to Old Navy. The good thing with Old Navy is they finished strong in the Q2. They had a plus 6 comp in July, which is good news. A number of things going on at Old Navy, all of their remodel stores were completed at the end of July. So that now gives that team about 260 new prototype stores in the marketplace.
Like where the new marketing is going. The new team has really taken the creative platform to a whole new level. I'm excited about that. I like what the pipeline is doing for product. You'll see definitely some improvement in fashion in the back half of the year.
The uniform business, which is one of these key categories we identified about 9 months ago has been a very big success for Old Navy. Back to school, be much more aggressive on uniforms, going after the market share with television, with product has been definitely a big success. The team is working behind the scenes of new category development, which we should see in 2011. I like the testing that's gone on that front and there's been some good real estate success in the Q2. A lot more stores to be relocated or being reduced in size to meet the prototype size for Old Navy.
So all in all, I think Tom and his team had a good plus 6 comp in July. I like what I'm seeing from that team and now Tom's job is to anniversary that performance we saw last year and to gain market share. Gap brand, let's talk about some of the accomplishments of Gap brand in the 2nd quarter. They also in a much lower scale than Old Navy completed 200 remodels towards their denim shop in shop 1969 look at every one of those stores is going to open this Saturday. They introduced the anniversary of the 1969 denim relaunch 2 weeks ago.
We put the new black pants into the store 2 weeks for the marketing for it is going out on August 25. What I like about the black pant relaunch, it plays off the success of denim. So it's a different wearing occasion, but very clearly it goes to the strength and the core of what made denim successful, which is fit. So we see that in the black pants with 7 unique fits and just to foreshadow in September, we're going to be launching a new sport pant and it's going to be called Gap Body Fit. So we're tying that nicely together.
The kids business came out with its 1969 launch in the month of June. And 2 weeks ago, our LA office opened for denim merchandising and design team. We announced that about 2 months ago, and we're very excited with that team and what they're going to be able to do for us as we look forward. However, Q2 was a minus 4 comp. And I know market and our team were disappointed and we've been spending a lot of time with them, not only taking some of the elements I just spoke about, but what else do we need to do at Gap brand.
And one of the missed opportunities, right at the heart of the challenges in Q2, there were just were not enough tops in the business and I want to say not enough great tops in the business. Take advantage of the marketing push we're having on bottoms. Now that's getting a course corrected through Q3 marginally and definitely much better in Q4. And I've seen some early indication of spring and we definitely are in a much better place then. Let me give you an update now on our growth initiatives with a real focus on international.
Our online site opened up in Europe this week, which is very exciting for European customers and a great win for our stores. That's going to be followed up this coming Monday with our Canadian site, which is going to open up. Canadian team is very excited about that as well. Also by the end of the month, we're going to open up our first store in Australia. So our franchise team will now have 150 stores and growing very quickly.
Everything is on target for China.
We're going to open up
at the end of October, Everything is on target for China. We're going to open up at the end of October in Shanghai and we're going to have 4 stores by the end of the year in Shanghai and Beijing. And very pleased with the team, how they've come together, their marketing strategies and how they're putting together a plan to win in strategies and how they're putting together a plan
to win in China. And Italy, which was the
other big country we announced a few months ago, we're going to be opening up in late November in Milan with both Banana Republic and Gap stores. So in closing, before I hand it over to Sabrina, I want to just take a few minutes and talk about our economic model. We've been speaking now for the better part of a year that we have a new strength in economic model at Gap Inc. What Q2 proved to me is also that economic model is flexible. In the early part of the quarter when we realized we didn't have the momentum we needed and plan for in the sales and gross margin line, we were able to flex down our economic model and take cost out of the business to deliver the healthy earnings we deliver in the Q2.
That's positive news. As we come into the Q3, we are all very confident in the strategy of the company. We need to grow top line and we have to push even harder to get market share gains in North America. Our global business led by franchise, online, global outlet, 2 new countries in China and Italy are really developing and coming together and become an even bigger part of our company's strategy. The economic model produces great cash flow and we will continue to give it back to shareholders as evidenced by the CAD800 1,000,000 of shares we bought back in Q2.
So all in all, we're looking forward to the second half. The business is very focused, very committed. The management team is going to execute at even higher level. And with all that said, I want to now hand it over to Sabrina to take you through the financial results for the Q2.
Thank you, Glenn. Good afternoon, everyone. For those of you participating via webcast, please turn to Slides 45. While we encountered a few more challenges than we anticipated when the quarter began, we're pleased that we met our goals of growing top line sales and increasing earnings per share. Here are some highlights for the quarter.
Earnings per share up 9% total sales up 2% with comp store sales up 1% online sales, which are not part of our comp base, up 15% operating margins, up 40 basis points to 12 percent and we returned nearly $900,000,000 to shareholders, dollars 800,000,000 in share repurchases alone. I'll now provide some additional detail on our Q2 financial performance. Please turn to Slide 6. We grew net income to $234,000,000 and delivered EPS of $0.36 versus $0.33 last year. Our effective tax rate for the 2nd quarter was 41.2 percent and our year to date effective tax rate is 39.3%.
Turning now to gross margin on Slide 7. Gross profit for the quarter grew 2 percent to $1,300,000,000 Gross margin for Q2 was nearly flat to last year, down 8 basis points to 39.6 percent as rent and occupancy leverage of 40 basis points almost entirely offset the merchandise margin decline of 50 basis points. Year to date, gross margin of 40.9% is up 120 basis points over last year. Looking at inventory on Slide 8. After 4 years of inventory reductions, we decided earlier this year to increase investments in key categories for fall, aiming to improve categories like uniform at Old Navy, denim at both Old Navy and Gap and the launch of premium black pants at Gap.
As a result, inventory dollars at the end of Q2 were up 11% to $1,600,000,000 And as expected, inventory dollars per square foot at the end of Q2 were up 12%. This compares to down 14% in 2,009 and down 17% in 2,008. Turning to Slide 9, operating expenses. In Q2, while making continued investments in growth, including the Old Navy remodels, the launch of our online businesses in Canada and Europe and the opening of our first stores in China and Italy, we leveraged operating expenses by 50 basis points, demonstrating our commitment to cost discipline. Expenses grew by $4,000,000 to $9.17 Included in total operating expenses is $101,000,000 of marketing, which is up $7,000,000 to last year, driven by our online brands Athleta and Piperline.
Please turn to Slide 10 for capital expenditures and store count. We ended the quarter with 3,070 6 stores and net square footage was down 2% compared to Q2 2,009. In the first half, we opened 19 stores weighted towards international, closed 38 weighted towards Gap brand and spent $248,000,000 in capital. Regarding cash flow on Slide 11. Year to date, free cash flow was an inflow of $292,000,000 We repurchased 52,000,000 shares in the first half for $1,100,000,000 Even after these share repurchases, we ended the 2nd quarter with about $1,700,000,000 in cash and short term investments.
At the end of Q2, we had about $150,000,000 remaining on our current $1,000,000,000 share repurchase authorization. And as evidence of our continued commitment to return excess cash to shareholders. We announced today a new $750,000,000 authorization. And now please turn to Slide 12 for our outlook for the rest of the year. Today, we are reaffirming our full year EPS guidance of $1.77 to $1.82 per share, which represents a 12% to 15% growth in EPS versus last year.
Let me walk you through our assumptions for the back half. As Glenn mentioned, we remain focused on driving sales growth. A key driver of sales growth is increased unit sales. And I stated earlier that we made calculated inventory investments for fall, which were just starting to sell through. It's always been our intention that following these initial fall inventory buys, inventory levels would come down over time.
In line with this, we expect inventory per square foot at the end of Q3 to be up in the high single digits. As a reminder, we remain focused on reducing square footage through closures and downsizes. As we drive top line sales growth on this declining square footage base, it's reasonable to expect some increase in inventory per square foot. Moving to operating expenses. Similar to the first half, we feel confident that costs in the base business will leverage as sales grow.
That said, our investments in growth initiatives increased quarter over quarter in the fiscal year and this could put some pressure on our ability to leverage total operating expenses in Q3. The following full year guidance metrics remain unchanged: Depreciation and amortization about $550,000,000 effective tax rate about 39 percent operating margin about 13% capital expenditures about $575,000,000 new store openings about $65,000,000 store closures about $110,000,000 and net square footage decline about 3%. In closing, we remain focused on our goals of top line sales and EPS growth, And we're very pleased that at the same time, we continue to generate and distribute significant amounts of cash, which we believe are an important component in meeting our overall objective of driving shareholder value. Thank you. And now I'll turn it over to Mark.
Thank you, Sabrina and Glen. Operator, that concludes our prepared remarks. We'll now open up the call to questions. And everyone, we'd appreciate limiting your questions to 1 per
person. Your first question comes from Janet Kloppenburg with JJK Research.
Good afternoon, everyone. Glenn, I'd like to ask you to focus on the GAAP assortments right now. And
I'm wondering why there's such an underinvestment in tops.
And given your lead times, I'm wondering when
a
It's a combination of the investment we made in denim combined with the incremental investment we've made in black pants. And those two in combination put us in a position for total inventory perspective that inventory is 1 pool. And when those investments got made, I'd say that from our perspective, that's a missed opportunity that while we made the strategic investment in bottoms, we did not leave ourselves enough room on tops. Now that's one component. The bigger issue I can say to you, Janet, was that even the tops we had in, given this imbalance, even with that, we just didn't have the right tops.
And I think the team in New York recognizes that, the team in San Francisco recognizes that. If you go to our store actually this weekend, I think you've seen the beginning and I want to make sure I'm clear just the beginning of some tops that have come in through a faster pipeline we've been working on for a year to complement the black pants. And I think that to the question you asked about timelines because we've been able to shorten the pipeline initially, I think you should notice and I've seen all the product over the next 6 months, you should notice a difference on October 1. I think when that product comes in, I think it's 9.20 8 to about the 2nd week of October, there's a bunch of new product coming in that complements a strategy we have on black denim. I think it should be something noticeable there for sure from my perspective, hopefully yours as well.
I think you'll also see a step up from there in
holiday and one more step up probably in spring. And then really, I think the balance we're looking
for will be established. And step up probably in spring. And then really, I think the balance we're looking
for will be established.
Now it's up to the design and merchandising team to keep that balance and then just continue to design into what the aesthetic and what the target customer is. There's a number of reasons why we didn't get
there and
it's too long an answer to give on this call. I should say, we didn't get there and it's too long an answer to give on this call. Let's just say that it's that more than a few months ago, it was clearly stated that that had to change. We're seeing slight improvement now because of this new pipeline we have. And I'd be surprised this fall if not only people on the phone, but more importantly that our customers don't notice the appropriate shift that arguably should have happened a number of seasons ago is going to take place starting October 1.
Your next question comes from Betty Hsien with Wedbush Securities. Hello? And Betty's line is live.
Hi, this is Connie actually calling in for Betty. I was wondering if you guys could talk about this current pricing environment. How does Mickey guys feel about the marketing campaign?
Are you talking about pricing to the consumer or costing to us?
Pricing to the consumer.
Well, the pricing environment from our perspective is no certainly no better and not any worse. This is the environment in which we operate. There is going to be moments where there is some deeper aggressiveness, whether that's driven by the beginning of a sales season or because some competitors are deciding to come up proactively and be more aggressive. But I think all in all, when you add it up and this is a business that week by week, if you measure an index on aggressiveness, it can be slightly better 1 week, like the week at which we're in, and it can change in any given moment. So I think that we're used to the fact that we need to make sure, 1, we're on top of what's going on in the marketplace.
Secondly, we stick to the plans we put into place. We react when necessary, we know clearly what is meaningful to us in terms of our value we know clearly what is meaningful to us in terms of our value proposition to consumers, when do we have to make an adjustment by brand, and every brand stands for something differently, different customer, different value proposition. But I definitely would characterize and I'm very close to it, I would say that the overall market when you average it out is still promotional, definitely still more aggressive than it was a number of years ago, but Q2 aggressiveness was no deeper and certainly no better than it was in Q1.
Great. That's helpful. Thank you.
Your next question comes from Edward Yruma with KeyBanc Capital Markets.
Thanks very much. You mentioned that once sales look like they were going to come in a little bit lighter than expected that you had pulled back on expenses during the quarter. Can you talk about specifically where you cut expenses and how sustainable that is should sales remain pressured? Thanks.
Sure. And our biggest pool of expenses is store related. So that's over 50% of our expense and a large piece of that is variable. And that's actually the one we can impact the most in the short run. The other large bucket of expense that we can impact is marketing.
But of course, marketing we view as driving importantly traffic for us. So we're very careful about changes we make to our marketing plan. So in Q2 where we were able to do better than we initially expected once we saw a little bit of softness in our sales was primarily coming out of the store related buckets.
Got you. Thank you. Your next question comes from Michelle Tan with Goldman Sachs.
Great, thanks. I was wondering if
you guys could talk about what kind of average unit cost declines you had in Q2. And I know you've talked about some opportunities still as you go through the back half of the year. What kind of declines we could expect for the second half? Thanks.
I'll start with that, Michelle. So we've talked about for some time coming into the year that we felt really good about the first half costing. And in fact, through the Q2, we didn't experience any cost increases. When we look to the back half, indeed, the pressure started mounting. So we've had to work really hard on the back half.
But I'm happy to say that on like for like items, we actually achieved our goal. And on like for like items, we're not really experiencing any cost pressure either. Now what we have done in the back half, as you know, because we've talked about it quite a bit and it's also impacting our inventory dollars per square foot is that we've made mix decisions more into bottoms as an example that has increased our average unit cost when just taken at face value actual because of course the bottom cost more than a net. So that's indeed happening in the second half.
Right. That makes sense. Any kind of color on magnitude of the decrease in Q2?
We've talked about coming into the year, Michelle, that they were greatly moderating from what we experienced in 'eight and 'nine. So I'll tell you very modest.
Thank you very much.
Your next question comes from Lorraine Hutchinson with Bank of America.
Thank you. Good afternoon. Just wanted to talk a little bit about the sales outlook with some disappointment at Gap and very tough comparisons at Old Navy. I guess how are you thinking about top line? And if it doesn't accelerate from the Q2, are there still some levers that you can pull?
And Lorene, it's Glenn. I would say that we are definitely thinking about the GAAP performance as you saw in Q4 of last year, they had a minus 1 comp and they got to a plus 2 comp in Q1 of this year. And then I look at Q2 more as I mentioned in my opening comments that all brands, but we're speaking about Gap right now, definitely have corrective measures they can take to get the business positioned the way we expect it to be, to deliver the growth that we've planned for with them. And so I look at their business and say that we may have mentioned a while ago that it's going to be a little lumpy when it comes to Gap brand given the 7 year history we've been dealing with. And maybe for now a 2 step forward, 1 step back quarters is something that from a patient's perspective, I'm willing to live with right now.
But at the end of the day, we expect a lot more from that brand. They're not anniversarying the kind of comps you referenced at Old Navy. I see some definite improvement coming, but just on the continue with the theme of patience, my patience is not indefinite. With the Old Navy business, Tom and his team are definitely up against some as you referenced some very good comps in the back half last year, but here's a reason to that team. They also have been giving up market share over about a 3 to 4 year period.
And regardless of the comps, the positive comps, which we were pleased about in the back half of 2009, we still expect that team to go out and grow their business and continue to get the market share because 1 year did not take them back to where they were. 1 year only set the business on the right course and the right trajectory. So we can't give numbers out as you know, but there are 2 different businesses that are both expected from us to grow their top line as we look at the second half of the year. Now always the intangible for us is the macro environment, as I talked about in some of my opening comments, but what is in our control is execution. And people in both those businesses know that we set their expectations for them and we expect them to deliver on them.
Your next question comes from Stacy Peck with SP Research. Stacy's line is
live.
Operator, we're not hearing Stacy's question.
Stacy, would you
like me to move on to the next
Yes, please.
Okay. Your next question comes from Evelyn Koppelman with Wells Fargo Securities.
Good afternoon. Thank you. I had a question on the international e commerce. When you think about how quickly that business can grow, if we think about kind of in the U. S, e commerce is 10% of sales.
How quickly do you think you can reach that point? And do you think actually you get there more quickly because you have fewer stores internationally? Can you talk about that? And we're trying to figure out how quickly it's going to impact the overall bottom line. Thanks.
It's tough to sit here today and say, well, we'll get here more quickly. Here's what I can tell you with the two recent investments we've made. So Europe first, which we opened up our site on Monday, the growth of e commerce in Europe today is significantly higher than it is in U. S. Today, just pure market.
And so for that reason, I think they're going to catch a nice wave probably similar to the wave we caught 10 years ago when we launched our first site here at gap.com. So I think we feel good about the fact that they're hidden at the right time. I think it's very newsworthy. And where it may be an advantage for us to at least get to the 10% and then this is now as we think about it, can you get the 10%, I think the answer is yes, and we're going to hold them accountable for that. Could it get higher is really how we're looking at strategically saying that should actually be higher than that because our penetration of stores, particularly in the UK and France, and what do you think the fact that's going to be in 9 other countries by the end of October and then spreading from there to a lot of countries where we have no store presence or limited store presence as we go to a city strategy in Western Europe as opposed to the strategy we have here in the U.
S, I think the opportunity is to at a minimum get to that level and possibly more down the road. In Canada, what we like about our opportunity is the Canadian sites. There's a lot of American companies ship over the border, but do not have specific sites in the country and their own distribution center and therefore you cannot return product to stores. I think that gives us a real advantage in the Canadian marketplace. So even though our penetration is not as broad as it is here in the United States, it's still pretty established in Canada.
So I think there's a slight opportunity, but the bigger opportunity being we are one of the few American companies or global companies I should say who have established a site specific in the country. So again from that perspective that should give us the advantage to at a minimum get to the 10% penetration.
Your next question comes from Brian Tunic with JPMorgan.
We're having trouble hearing the questions on our end. We'll try Brian again.
Your next question comes from Jennifer Black with Jennifer Black and Associates.
Good afternoon. I was I wanted to know about the kind of results you're seeing with regard to social media, specifically Foursquare, Twitter and the recent Groupon offer. Was the Groupon offer planned? And do you intend to use it again? Thank you so much.
Definitely, all these offers are planned, I think in particular Foursquare and Groupon which came out today. Those are definitely all offers that our team here and I'd say, I'd say Gap team in particular leading some of those efforts working with our CRM team here in the office that do work across all of our brands are definitely we've been pushing that quite a bit. We've been working with different companies that have been helping us to unlock social media. Social media reminds me a little bit of when I was in a different business over a decade ago and CRM came out and loyalty programs came out and the only way they can be successful is if you really just don't follow what the pack does, but find innovative ways of doing things. So I'm actually been encouraged and recognized the customers that we are trying to build deeper loyalty with.
I would say the younger end of our scale of demographics are people who are, now this is obviously motherhood statement, get information differently, behave differently and don't actually react to maybe traditional ways of marketing as much as some of the customers we have. So we've been working hard for the better part of the last 6 or 9 months to make sure we understand what are the right tools, how do we make sure it fits appropriately for the brand. And, Jennifer, this is the beginning, I believe, of more and more of our time, marketing investment, communication and customer loyalty build happening at different mediums than we've used in the past. Whether we use Groupon again, that's to be determined. The one thing I also know about communication is you can't go to the well too often.
You have to make sure and we've made that mistake a few times in the last 3 years. So when we have a new communication vehicle that we think is successful and it's fresh, you got to make sure that you do it and you learn from it, but you don't over abuse it, in which case I think some of these customers do not want to have excessive communication. They want the right communication. And I think in this case on the 2 that you referenced for sure, I think both
of them so far have proven to be well received by the customers
we're going after. Great. Thanks so received by the customers we're going after.
Great. Thanks so much.
Thank you.
Your next question comes from Stacy Peck with SP Research.
Don't tell me you still hear me. Can you hear me? We can hear
you now.
Oh, God. It's getting to bug me. Okay. So I just want to know what's the read on black pants? I know the advertising doesn't kick in yet, but it's been in store for a little while now.
So I wanted to know the read on black pants. And also how well does Old Navy's assortment compete beyond uniforms? It seems like you had a great uniform promotion in July. What about the rest of the assortment there? And is that the kind of thing that we should expect from Old Navy in the back half?
Do they have more of those up their sleeve? Or how should we be looking at Old Navy? Thanks.
On the Old Navy front, let me answer that first, Stacy. I'd say that we were what we like about the uniform piece, we've been saying this for a few quarters now, I think that it was based on strategically what that
customer wants and kind of customer shops Old
Navy, but also some customers we wanted to get customer wants and the kind of customer shops Old Navy, but also some customers we wanted to get deeper relationships with, it was planned well ahead of time. The marketing was fully integrated with online inside the store and the television marketing and we bought inventory. And I think we hit the right price point, we gave
them the right space in the
store, And I think we hit the right price point, we gave it the right space in the store and your question about whether you expect more of that, I think the answer is yes. I think we definitely expect that that kind of coming out strong, clear market share gaining initiatives, playing to our strength, using the space we have in the store, buying the inventory right and going right to the heart of the customer we really want to have is something that Tom and his team, as I look their marketing programs over the next 6 to 12 months, not identical to what you saw in the Uniform event that started about 10 to 14 days ago, but in the spirit of that, you'll see more of that going forward. I think the television that comes out tonight is about hoodies for the family. And I think that also has a similar play that you've seen take place last 2 weeks when it comes to uniform. So not every week we'll have that feel, that kind of commitment, but definitely within a quarter there'll be more programs like the Uniform.
Yes. And then really quickly on the Black Panther, we're obviously going to say a lot more when we report August sales, Stacy, but they start just started flowing in, in July. And we talked about the fact that we were really pleased with early, early reads. August is an important month. September will be another really important month for black pants, because it's
true fall for that target adult customer. But so far so good as we
saw in July. Okay. Thanks. Good
afternoon. I
Thanks. Good afternoon. I want to sort of dive a little into the gross margins for a second and also your 13% operating margin, I guess target ish for the year. I guess Sabrina, this looks like it's the Q1 that you've had down gross margins and merch margins in quite a long time. So I guess the first question is trying to understand, it looks like you did get rod leverage, which we didn't think was possible on a one comp this quarter and all the Old Navy remodels.
So we are curious what was happening there. And then on Glenn's comments about taking market share, should we be thinking that merchandise margins are now going to start being down for the back half of the year?
Yes. Great question, Brian. So I think I just want to start with a little bit of context on the merch margins, because I think as you guys know, since 2,006, we have actually expanded our merchandise margins by over 700 basis points. And we hit all time highs for this company in 2,009. So we began to signal as we entered 2010 that especially in this kind of fragile customer environment, we didn't want to keep overworking that one lever.
And that where we really saw our opportunity going forward as sales grew was to leverage Rod. So we felt comfortable for some time that on any positive comp, we can leverage Rod, which is what we were able to achieve in the Q2. The amount of leverage we get is kind of hard to predict. It's not like straight math, because we have factors like foreign exchange, net book value write offs, amount of co tenancy failures and remedies, all kind of moving parts in different divisions. But we always felt comfortable that, that would leverage.
Deterioration in Q2, the absolute with a small deterioration in Q2, the absolute merchandise margin is very, very healthy. And the fact that we drove positive gross margin dollar growth is really kind of where we want to focus on in driving earnings growth and shareholder value.
Terrific. Thanks and good luck.
Thanks.
Your next question comes from Dorothy Lachner with Keyurice and Company.
Thanks and congratulations on the quarter. Going back to the denim category, you've obviously had lots of success since the launch of denim premium denim at Gap. And you talked about better funding the denim after you moved out of the launch period last year in this quarter when there were quite a few out of stocks. So as you talked about inventory and the increases that you've been seeing in inventory starting to taper off, I'm just wondering how you feel about denim inventories. It seemed like with the last promotion that there were some out of stocks in the stores that I checked.
So I'm just wondering if you feel comfortable with the level of denim you have going into the back half of the year given its success?
Yes, we do feel comfortable. I mean, I think with a fleet as big as stores, so there's about close to 1100 gas stores in North America.
And I didn't go to all of them.
Yes. It's really hard to go from perfection in terms of every store being in stock at every single size. But we think our investments are really appropriate and we stood behind those in a big way. So we're comfortable with the inventory investments in that. We actually over time, right, want to make sure that with these big fall investments we've made, as I said in my prepared remarks, we do want to make sure that we're bringing that relationship of inventory back more in closely line with sales.
But we're good so far.
Okay. I can add to that, Dorothy. There's clearly areas that as you hindsight everything, if you look at Gap stores right now with the launch of the leggings business that they put in that segment that came out about 4 weeks ago. I think that they try to buy it appropriately. They do all the algorithmic work you could ever imagine.
But at the end of the day, that's one we'd sit back and go, I wish we would have bought more of that because that went very quick in our stores.
Yes, it did.
And we really where we have no different than the 5 pocket launch a year ago. We have the fabric, we're ready to go, it's on the water, it's coming in. I know I was in Old Navy stores last Friday in Seattle and no difference in them. They put out kids' denim for them.
They put out kids' denim for the program they have going on
right now and the promotion that's going on in Boy's Skinny was completely sold out in a couple of stores. I guess they never thought it was going to turn out to be 42% of their business. And that's, again, it was going to turn out to be 42% of their business. And that's again, but they're ready to replenish, but it's coming in this week. So I think that I always look at these things and go bottom line is unacceptable.
It's easy for me to fall for the fact these things happen. I think the teams are more and more focused on managing in stocks. One of the reasons the inventory level is at 12% is we've been pushing the teams to try to get to a better in stock level. So our customer satisfaction scores, which were not great a year ago, which are now really getting stronger
make us
feel good because we've certainly put a lot of time and try to make sure make us feel good because we've certainly put a lot of time and try to make sure we understand it, move inventory around, allocate it properly. So it's unfortunate it still happens, but I know that every time we get out of the stores that we see at the stores here react to it and adjust their levels to make sure it doesn't happen again.
Okay. Good to hear. Good luck.
Thank you.
Your next question comes from Marni Shapiro with The Retail Tracker.
Hey, everybody. Good afternoon and
I was curious if you can
give us an update on the direct business in aggregate including Piper Lime and Athleta and if you're seeing very different trends online that you're seeing in stores because clearly this business
has been healthy across the board at most retailers and you guys have
a unique platform that the board at most retailers and you guys have a unique platform that involves some businesses that have stores, some don't. And I was curious if you could just talk a little bit about it.
Well, we had a good quarter online. We're up 15%. So we were pleased with that number. And our online business have been perennial market share gainers except for maybe 1 month last year. Tobey and the team have pretty much had a 6 year run.
So I think the universality platform has certainly helped the adding of Piper Lime, as you know, when it was launched 4 years ago, was strictly in 1 category segment, which was shoes, then they added handbags, then they added accessories, which was mostly jewelry, then they added apparel. And we're really liking the momentum we're seeing out of pipe lines. I mentioned in my opening comments,
what we do at a
pop up store for fashion night out in New York. And I think in that 10 day or 15 day period, they're going to have that store and I think Rachel is always going to be there a couple of nights. I think you're going to see the next wave of where pipeline is going because we're not resting where we are today. There's a lot more that that site can become and turn into. We're very excited about the strategic direction.
Athleta too, very strong response to the catalogs, a bit
of a shift towards more performance products.
So I think Athleta is the perfect marriage of more performance products. So I think Athleta is the perfect marriage of strength and beauty, a little bit more on
the strength side, not at the expense of
beauty necessarily, but we're putting more of our product, our marketing and our focus on the strength side of its assortment. And that's really resonated. It's doing it very well. Assortment. And that's really resonated.
It's doing it very well. So both of those new brands, which are young brands for us, but as we said at recent meeting with investors, we'll definitely speak about in October when Toby addresses everybody at the Analyst Day, really have high hopes for those brands, not just today, but where they're going in the next 3 to 5 years. So overall, I think we're pleased. I think that that's a well run business. The investments we've made in software for universality have paid off and these 2 new brands are certainly part of our future.
Very exciting. Congratulations and good luck.
Thank you.
Operator, we have time for just one more question.
The final question comes from Roxanne Meyer with UBS.
Great. Thank you. You are up against a pretty strong denim performance last year at Gap. So I guess I'm wondering if performance of denim and black pants, if they do well, will that be enough for you to generate positive comps if tops do stay soft? And then when you think about the tops gradually improving throughout the fall and into spring, what is it about that moment that makes you think that you like the direction of where they're going?
What is it about them that they're how are they positioned differently? Or how have you changed the silhouette or the looks of the tops where you think you've got the right balance now? Hi, Roxanne. I'll start. With regard to the top, we've talked about some time that we've realized that we've needed to put kind of more femininity and more emotion into the top.
So they got probably a little bit too androgynous and a little bit too commodity like and basic like. And I think it's a marketplace where people's dollars in their wallet are precious and they really need that emotional aspect of the product to throw them over to the POS line. So that's really what we've been working on and that's what Glenn is talking about when he says that he's seeing that improvement come through marginally at first. It's always a work in progress. I think the team did a much deeper dive on improving that full line of tops when you look at the spring tops that come out in January, but you should see some marginal improvement as we go along.
With regard to comping ourselves, I think, as Glenn said, everybody knows that the name of the game in Q3 is about execution. We've had these plans in place for some time. And even though we're going up against better numbers, we know that we've lost a lot of productivity over the years and we absolutely need to stay on a path of getting that back. So we are focused on using all of these opportunities with regard to our assortments, our marketing plans, our promotional plans to try and drive that. That is the goal.
And just one thing I can add. We made a change late last year and made Patrick Robinson in charge of total global gap design. And I think the benefit of that is going to show up not only to our stores in Europe and in Japan and soon to be our stores in China, but really North America is going to benefit from that because the global team we now have in New York and again that's why that was an announcement we made without explaining some of the reasons we did it and it wasn't just done for synergy reasons and for continuity of the brand around the world. Patrick's team in New York have 5 people who work in the team in New York who are Japanese designers. Patrick's team in New York have 5 people who work in our European designers.
And the injection and the knowledge of what's going on around the world because they have trend managers on the
the
Patrick's team when really it's their collection, they're accountable for it. The merchants buy off and support it, but at the end of the day, we hold the designers accountable for the Gap collection with this new team that's come together, it's really starting to work very well. I think part of that is their influence and their injection from what they're seeing in their own countries where the North American merchants are now being exposed to that. That's why I see a slight improvement in October, a little better in coming the holiday and definitely a little better in spring and that's not from our lack of recognition we need to get to as Sreedhar taught you femininity, I think we just have a team now that is given us great information and that's long term, assuming we execute and we will execute. It's one of our advantages is to have a global design team with people representing the world, injecting into one line that our merchants around the world can buy from.
And I think that's one of the changes was made late last year, but the insight. Best of luck. Okay. We'd like to thank everyone for joining us on the call today. As a reminder, our earnings press
release, which is available on gapinc.com, contains the full recap of our Q2 results as well as the forward looking guidance included in Sabrina's remarks today. And as always, the Investor Relations team is available after the call for any further questions. Thank you.
This does conclude the Gap Inc. 2nd quarter 2010 conference call. You may now disconnect.