I would now like to introduce your host, Mark Webb, Vice President of Investor Relations.
Good afternoon, everyone. Welcome to Gap Inc. Q1 2010 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, 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 May 20, 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 the 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'd like to turn the call over to Glenn.
Thanks, Mark. Good afternoon, everybody. Let me just make a few comments before we hand over to Sabrina, who will give you the financial update for Q1. First off, in general, we were pleased with our performance in the Q1. One of the metrics we have been looking at a lot more closely in the last year or so is what does our growth look like in the top line.
So in the Q3, we flat comped. In Q4, we were plus 2. And in Q1 of 2010, we had a plus 4 comp. So, going in the right direction, we felt good about that. With that said, it's still a very volatile consumer environment.
I finding it personally, having been a retailer for over 20 years, that it's just very difficult to predict patterns, week to week, weekday to weekends. Most importantly to me though is we're able to take that improving top line and really leverage the business. And we've been talking a lot about that here internally. Once we start turning our attention towards top line, how do we maintain that discipline we work so hard on? So getting 290 basis points of leverage on the operating margin line was important to me.
I'm actually pretty proud of the teams. Getting off to a good start of the year is critical in any business. So I'm glad that we came out, had a good performance, delivered our expectations. I think that sets us off well emotionally for the rest of the year and get off to a good start in the Q1. There's certainly a few areas that I'm focusing on as I look forward to the rest of the year.
I am looking for a little more intensity when it comes to our value proposition messaging in the business. I'm looking for a bit of a stepped up effort in our business around our category strategies and the dominant position we're going to take within brands on key categories. And lastly, I'm looking for the teams to show some improvement on the consistency
of our product delivery.
If we can get some traction on those three key components, along with the culture of discipline, I think it will set the business up well for continuing to perform at a respectable level going forward. Let me now turn and give you a quick update by brand. Old Navy had a very good Q1, particularly in kids and baby. And I think we've spoken before on this call that the way we look at Old Navy is that that key customer buys for her family first and then buys for herself. And the kids and baby business, under great leadership, has really had a good quarter and a market share gaining quarter.
The new stores we're doing, the remodel stores we're calling Project 1, 100 of them got done in Q1, but in fairness, the majority of those opened on the last weekend of the quarter. So, we're not going to see the benefit of the repositioning of those stores until the Q2. Some work is being done by Tom Wyatt and Nancy Green right now to tighten up the assortment a little bit. I think their view is the assortment probably got a little too broad over the last 6 months. I think there's some good work going on there, which I'll see in the second half of the year.
And everybody at Old Navy is very excited about our new CMO joining us, Amy Curtis, a very talented person, great resume, great experience, and I think she's going to make a real difference in the position of that brand to our consumers. At Banana Republic, Julie and Simon are working well together, seeing some definite benefit in products in the key categories they're looking at, seeing that show up in pants and in sweaters, just two examples of categories they're very focused on. Our new store remodels for Banana Republic are doing quite well. I'd encourage anybody who hasn't seen them to go to SoHo, I was just there 2 weekends ago for the relaunch of that store on Broadway. It's a beautiful looking store doing extremely well on all metrics.
And one key win, I would say, in the Q1 for Banana Republic is in the clearer definition of the heritage and the differentiates Banana Republic, and Jack and the
team have done a really good job, and we'll see
that more and more coming to market as we look further into the year. At Gap, there's a lot of work going on with the team. We talked last quarter about some reshuffling we did of executives, and we have very high expectations of that brand to start showing some better traction and some improvement in its business. I am pleased with the rhythm I'm starting to see in denim on the heels of 1969 coming out every month with patch and repair, white denim. This next month is bleach denim.
I think they're really getting how dominant we can become in that category and start to build momentum on it. Speaking of 1969, I should also mention that we opened our 3rd 1969 store, which is obviously a very strong denim expression for us and we're learning in those stores, learning how to merchandise, learning about fixtures, learning what customers expect from a brand like 1969 denim. We're taking those learnings and we're putting them back in to the core Gap stores. As a matter of fact, we're going to be spending
a little bit of capital in
a couple of 100 stores, which will be opened up by the end of July to coincide with the anniversary of last year's launch of 1969. And we just announced last week that Rosella Giuliani is going to join the company. Rosella is the senior merchant and designer over at 7 For All Mankind, phenomenal denim expert, and we're going to move our whole denim team from New York over to LA. One of the strategic decisions we made was to move that team under Rosella's leadership, working with Patrick Robinson, working with Pam Wallach to bring denim to the next level inside of Gap stores. That team is looking forward to the relaunch of black pants, which will be in our stores on July 26 and will be marketed at the end of August.
I think we are holding that team accountable to try to get the same kind of performance on the black pants that we saw in denim, use it as a springboard to not only buy loyalty, but get new customers into their stores. Let me just give you a quick update on international business. Everything is progressing very well in China for a late fall opening
of the Gap brand in the Chinese market. And I
see some very good progress the team on strategy, definitely some thoughtful ideas when it comes to our value proposition. And really, the real estate team is starting to get good traction. But Anne Republic opened up its 3rd store in Europe, Covent Gardens in London. Its early indications is it will be as successful as the first two. So we're very pleased about how Banana Republic is progressing.
A couple of more stores to come this year also in London, and we're looking forward to open up in Paris in early part of 2011. Our Italy launch is progressing very well. Looking forward to our launch is progressing very well. Looking forward to our Milan store openings, both Banana Republic and Gap, late fall of this year. And we're starting to see some potential opportunity in Rome.
More about that later on, but that's more of a 2011 opportunity. Online launches are on target for Canada and Europe. As we talked about on the last conference calls, they're going to launch in the month of August. Our global outlet team has been very busy this quarter, adding new stores in Canada, new stores in Japan, new stores in the UK, testing a few new concepts. So I'm pleased about that.
They have put together an excellent strategy for China. And lastly, we will be testing a store, a brick and mortar store for Athleta later this month. It's a test. But as I've indicated before, when we bought Athleta, there was a number of steps we had to get through, integration, putting them on the universality platform. This is the next evolutionary step for Athleta.
We feel very good about the performance. We've seen well ahead of our expectations in the Athleta business, and this is the natural next step. So that's an update on Q1. Let me now hand it over to Sabrina to take you through the financial update, and then I'll be happy in a few minutes to answer any and
all questions that you may have. Sabrina?
Thank you, Glenn. Good afternoon, everyone. For those of you participating via webcast, please turn to Slide 4. Over the last few years, we've worked hard to strengthen our operating model. Our merch margins are at 10 year highs.
Our expenses are tightly managed. Our operating margin is expanding and our earnings and free cash flow are growing. Now as we focus on driving sales, it's our intent to continue leveraging this operating model. Doing so enables us to make investments for the future while delivering earnings growth and distributing cash to shareholders. Our first quarter performance represents good progress against our goals.
Here are some highlights for the quarter. Comp store sales were up 4% with all North American divisions posting positive comps for the quarter. Gross margins were 42.1%, up 2 50 basis points. Operating margins were 14.2 percent, up 2.90 basis points. EPS grew 45% and we generated $222,000,000 of free cash flow.
Please turn to Slide 5 for our earnings recap. In the Q1, net income grew by 40% to $302,000,000 and EPS was 0.45 dollars versus $0.31 last year. Included in these results are about $0.02 of benefit related to the favorable resolution of tax issues in the quarter. About $0.01 of the benefit is reflected in interest and the other $0.01 is reflected in the tax rate. Please turn to slide 6, sales and gross margin performance.
Our strategy is to drive sales by selling more units while maintaining the healthy margins we've achieved. When we do this, rent and occupancy should leverage and gross margin rate should expand. In Q1, total sales grew 6% to $3,300,000,000 Gross margin expanded 250 basis points to 42.1 percent with merch margins up 160 basis points and 90 basis points coming from rent and occupancy leverage. Gross profit dollars grew by 13% to 1.4 $1,000,000,000 Looking at inventory on Slide 7. Inventory dollars at the end of Q1 are up 10% to $1,500,000,000 After 4 years of Q1 inventory reductions, we've begun making targeted investments back into key categories like denim.
In addition to supporting our goal of growing sales, these investments build in stock levels to improve the customer experience in our stores. And we've also been reducing square footage. These actions combined result in inventory dollars per square foot up 12% this year. This compares with Q1 'nine inventory per square foot, which was down 12% on top of Q1 'eight, which was down 17%. Turning to Slide 8, operating expenses.
In Q1, we continued to demonstrate cost discipline. Despite investments in growth, we were able to leverage operating expenses by 50 basis points. Operating expenses grew $41,000,000 to 9.20 $1,000,000 Marketing grew $17,000,000 to $113,000,000 driven by Old Navy and our online brands Athleta and Piperline. Please turn to slide 9 for capital expenditures and store count. As I mentioned earlier, we've been reducing square footage, primarily at Gap and Old Navy.
We ended the quarter with 3,085 stores and net square footage was down 2% compared to Q1, 2009. We opened 9 stores weighted towards international and closed 19 weighted toward Gap brand. 1st quarter capital
Brand. 1st quarter capital expenditures were
$107,000,000 Regarding cash flow on slide 10. For the quarter, free cash flow was an inflow of $222,000,000 compared with an inflow of $139,000,000 last year. We repurchased 14,000,000 shares in dollars last year. We repurchased 14,000,000 shares in the Q1 for $296,000,000 and we ended the Q1 with about $2,500,000,000 in cash and short term investments. And now I'd like to discuss our outlook for the rest of the year.
Please turn to slide 11. As I've said, we plan to drive sales growth while maintaining the healthy merchandise margins we've achieved. Doing so should leverage rent and occupancy costs. Going forward, the opportunity for further gross margin expansion will come primarily from rod leverage. The primary driver of sales growth is increased unit sales.
Similar to Q1, Q2 inventories have been declining since 2,005. In order to improve sales productivity and drive comp, we are prudently building inventory in low risk categories. We expect Q2 ending inventory per square foot to be up in the low double digits similar to Q1 and that compares to negative 14 14% in Q2 last year and negative 17% in Q2 of 2018. Moving to operating expenses. We expect the investments in our growth initiatives to be higher in Q2 versus Q1.
In addition to remodeling another 80 Old Navy stores, we are now beginning to incur expenses related to the launch of our online businesses in Canada and Europe and the first stores in Italy and China. We expect our base business to continue to leverage operating expenses as sales grow. However, total operating expenses, including growth investments, may slightly delever in the Q2. With regard to occupancy costs, we still expect leverage on positive comps. But given the increased investment in growth initiatives, the amount of leverage may be lower in Q2.
We're very pleased with our Q1 performance and our outlook for the year has improved. That said, our biggest selling quarters are still ahead of us and volatility remains in the economy. We are raising our estimate for full year earnings per share, which we now expect to be $1.77 to $1.82 up from our previous guidance of $1.70 to 1.7 $5 This guidance includes the dilutive impact of our growth initiatives and implies double digit EPS growth. 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 net square footage decline about 3%.
In closing, we're pleased with how we executed against our strategies in Q1 and are encouraged by the progress we're making to improve top line across all our divisions. Thank you. And now I'll turn it over to Mark.
Thanks, Sabrina. Operator, that concludes our prepared remarks. We'll now open the call up to questions. And everyone, we'd appreciate limiting your questions to 1 per person.
Your first question is from the line of Michelle Tan with Goldman Sachs. Great. Thanks. I was wondering if you
could talk a little bit about the inventory growth. It's higher, I think, than the mid single digit you talked about last quarter. Wondering what the driver is? And then any color on particular categories that you're investing behind? Thanks.
Yes. Hi, Michelle. I'll take that. Let me start with maybe why overall inventories are higher and what we're investing in, and then I'll tell you about the delta between what we expected earlier in the year. So as I said in my remarks, I think the most important thing is to remember for context is that probably unlike most of our competitors, we've been cutting inventories for 4 straight years.
So if you look at our 2010 ending inventory up 12%, it's actually still down about 30% from like 2,005. So from any absolute perspective, the inventories are really still quite lean. The other driver to the increase is the fact that as we're trying to improve sales, have positive comps, our square footage, as you know, is down. So if you think about the math of that, to drive sales and a positive comp when square footage is down,
mathematically, you're going to want to have more inventory
per square foot. So that's the you're going to want to have more inventory per square foot. So that's the second lever. Then also because of the 4 years we've been bringing inventory down, with now some momentum behind us, we really want to make sure that we don't disappoint our customers as they're coming back into us. And so we're purposefully investing in some categories to be in better in stock position.
So the biggest categories are going to be denim. And then like for example, our fall launch of black pants is another category that we want to get behind. And we're actually incorporating lessons from last year. As you all might remember, when we launched denim and that was quite a successful launch, we ended up being probably too lean in hindsight, especially in some styles and in the smaller sizes you might remember. So when we launched black pants now, we're purposefully going airing on being on the heavier side because we don't want to disappoint our customer.
We feel fine about that investment because it's not we're going to stand behind denim and black pants for some time. It's not a highly liable fashion item. So we feel like from a risk perspective, it's a really good bet to get behind that for the black pant launch. With regard to the delta between where we thought it would end and where it actually ended, that's actually mostly an in transit issue that we're just heavier bringing in new goods into May. Mostly it's Old Navy new goods versus L year LY, the in transit heavier.
We were pretty lean going into summer last year, so we have quite a bit of fresh goods coming in this year.
Great. Thanks for the color. Sure.
Your next question is from the line of Kimberly Greenberger with Citigroup.
Great. Thank you. Good afternoon. Glenn or Sabrina, could you just remind us what your longer term operating margin goals are for the business? And what do you think are the 2 or 3 key drivers that get you to that goal over time?
Thanks.
Yes. I'll start with that, Kimberly. I mean, we actually do operating margin guidance sort of 1 year at a time. So we're definitely looking for expansion in 2010 from 2,009. We said about 13%.
From a longer term perspective, look, do we feel that there's anything holding us back from sort of solid mid teens? No, we don't. We feel like we're on a good path. We're always trying to balance short term driving toward that with our long term goals of investing in growth initiatives. So we're always going to go for expansion, but with an eye to investing in long term growth as we do that.
So we'll give you more explicit guidance 1 year at a time, but we feel good about eventually getting sort of to mid teens. And then I'll just turn it over to Glenn. The drivers really quick of that expansion are going to come from gross margin. So we've talked about the fact that if we're successful with growing sales, our rod is the primary lever to expanding gross margin. So that's one big lever.
The second lever being we're going to stick very disciplined on operating expenses. And as top line sales improve that over time also has room to leverage.
And one thing I would add is that we've been studying and dissecting the operating margin for Zara, H and M, Uniglo and for the most part of the last few years they've been perennial high teens, in some cases low 20s operating margins and we've been spending a lot of time with the team here. We're not saying that their economic model should be our economic model. We look at Inditex in 75 countries, we look at H and M in 40 countries operating. And as we put the emphasis in the latest investments we've been making particularly in outlet and in on line, which are high return on sales businesses for us and high ROIC businesses for the company. I think trying to find the right mix of our portfolios as we go internationally and some other decisions we want to make based on some lessons we've learned from them and how they look at their business, how they approach their business.
Given our size and our multiple brands and a lot of similarities between us and Inditex, we've been using that as a bit of a let's call it an operating margin North Star within our business to say how far can we go and what's structurally different between our business and some of these 3 other companies, global companies who we admire and why we couldn't take steps in that direction. So that's putting a number out there and that's a number we're committing to, but there's a lot of lessons to be learned by those 3 other companies.
Great. Thank you.
Your next question is from the line of Betty Chen with Wedbush Securities. Thank you. Congratulations on
a great quarter. Glenn, you alluded to earlier the volatility in the marketplace. I was wondering if you can give a little bit more color around that and some of your value messaging or where you want the team to focus on in terms of achieving the market share goals that you have laid out this year and whether that has changed any of your targets in terms of the amount of market share you would like to regain or the buckets that you like to chase after? Thank you.
You're welcome. There's no there's definitely no change in the market share approach, but the volatility, I can't believe for a second is unique to us. It's a market dynamic that's going on. What I try to say in my opening comments is given the amount of years I spent in retail, it's not often that you look at a normalized week, let's take this week and look at a business that you do certain sales on Tuesday, there's a natural predictable bill from Tuesday to Thursday. Some of those predictions that history we've had in our business for many years, on some weeks it goes counterintuitive to what we thought was going to happen.
So what we've done is recognizing that maybe that's the new normal, maybe that Memorial Day weekend in 2010 is not going to trade the way it did in 2,007 because we are in a new environment in terms of how the consumer responds. All we've done, which I think we have a bit of a head start versus other people, maybe we're a little more committed to doing this is as we lay out by brand and by channel, our marketing and merchandising plans over a 52 week basis, we've worked into those enough flexibility that we can make very quick decisions that we could have made a couple of years ago. And that can be up or down, because of the ability for us to now read the business, stay to the course, which is ideal, like any retailer would say, if it was 100% predictable and you could just stick to your plans, that's the perfect scenario for all of us. Given the fact that's not reality, we have worked hard here to make sure that all of our plans have enough flexibility to make good decisions very close to key dates, very close to key seasons, and the teams, I'm pretty proud of what they've been able to accomplish.
It's a new way of thinking for us in general. It's probably not a new way of thinking for some other retailers and other sectors, but definitely I would say it's a new way of thinking for people in specialty apparel. But definitely I would say it's a new way of thinking for people in specialty apparel. So we've
been gaining experience with that, learning lessons
over the last couple of years. And now the notion of contingency, what people ask about all the time is, I think, what's much more fluid between what our plans are, what options do we have, I think what's much more fluid between what our plans are, what options do we have, how close to the actual date can we make those decisions. And that's just something we've had to adjust to, it's fine. The market is the market and either you can fight it or you can adjust to the circumstances that we're dealing with and we've chosen to adjust to them and make sure we make good decisions every single week and every single month.
Thank you and best of luck.
Your next question is from the line of Brian Tunick with JPMorgan.
Yes, thanks. Hey, I guess Sabrina, I was wondering on your merchandise margin commentary as guests as we go through the year. Are some of those comments related to maybe where historical markdown rates might be versus today or is there something happening from the sourcing side? I'm sure everyone's focusing on that. And then also, does your guidance include the $0.02 benefit from Q1?
Yes. So I'll take the merch margin comment first, Brian. So really all we're highlighting is the fact that we've made tremendous progress over the last few years on merch margin. If you just look at Q1 alone, we're up almost 600 basis points from just our 2,007 merchandise margin. So in this environment, you just don't want to overuse that lever.
Now we're going to continue to look for opportunities in merch margin, but what we're signaling is given that we're sort of at certainly decade high merch margins, if not all time high merch margins, that's a bigger opportunity in expanding gross margin really comes from rent and occupancy for the simple reason that during this period that we've been really marching up on merch margin. As you all know, our rod for the most part until recently has delevered. So in contrast to that merchandise margin expansion, rod has delevered 250 basis points full year 2009 compared to full year 2005. So that's quite an opportunity for us. Again, our strategy now given that we've achieved very healthy margins is more around let's sell more units at the healthy margins, get top line sales up and make sure we start leveraging rod.
So that's the primary focus even though we're not giving up on merch margins. So that's the first part. With regard to the guidance, yes, we kept our effective tax rate at 39% for the full year. We just got a benefit from these resolutions in Q1. So the way to think about that is it's almost like a timing shift.
We're getting more of the benefit in Q1 and the tax rate comes up a little bit in the out quarters. So the full year guidance definitely incorporates that that's just a timing shift.
Sabrina, can I just ask just trying to a little more get clarity on that? It's basically is it sourcing or is it markdowns that present more of the challenge as we go through the year?
Well, with regard to our markdowns, we still think we have an opportunity there. We've been doing really well with markdown margin rate. So as we've shifted into some healthy reg price selling, more in reg and promo, we just don't have as much pressure on markdown. So we've gotten great markdown margin expansion. That's not necessarily over at all.
With regard to average unit costing, we made a great deal of progress in 'eight and 'nine. We're still doing just fine in 2010, although we flagged long ago that that definitely would be moderating as the year went on.
Terrific. Thanks and good luck to the team.
Thank you.
Your next question is from the line of Jeff Black with Barclays Capital.
Hey, thanks and congrats And not to harp on it, but it's the first time we've seen inventory rise like this. And I hear what you're saying, but could you give us a better explanation of just how much of this is devoted to the Black devoted to the Black Pan initiative? How much of the build is devoted to clearing up in stock or bringing up in stocks where you need to? And how much of the build might be devoted to initiatives at Old Navy or the other divisions? Thanks.
I mean, I'd say broadly speaking, Jeff, that probably the bigger chunk of it is devoted to making sure that in key categories that we're going to stand behind for a big chunk of time that we're in better in stock position. That's the big chunk of it, whether it's Old Navy or whether it's gas, that's really going to be the primary piece of it.
Gwen, do you want to talk about in stock?
The thing we've done, Jeff, is I think we've looked at our business probably a little differently than we did historically on by brand, looking at our customers and we've spent a lot of time even during the depths of the recession where we were mostly applying very rigorous disciplined inventory management, not quite understanding where the customer is going to settle, now that we're at least at a different period and maybe sort of we're no longer having to deal with the thought that maybe things are going to get worse and we're at a bit of a standstill right now in terms of the economy and the consumer. We did some previous work a year ago, which was what are needs and what are wants that each one of our customers has within each one of our brands. And I think when it came to needs, we really felt and did the analysis that we were not satisfying them, we were under delivering and if you put your customer management hat on only, we were finding that a lot of people were telling us that they were just disappointed when they came in for certain things and we hit some of the categories today that Sabrina talked about, we were just not delivering for them 52 weeks a year.
And that's for me in particular, having come from different industry, that's very disappointing. Now I kind of understood it. In parts of 2,008, 2,009 where we're making some very big decisions on the fly and trying to figure out exactly where the consumer was going to land. But now while the picture is not crystal clear, but clearer, we decided to embark on starting with what categories do we want to really go forward and buy brand, we want to have gainshare and be more dominant and make sure the inventory goes into those categories first. It just so happens as you look at inventory and inventory is a mix of different products, it just so happens a lot of the categories that we're choosing to be strong in within brands have a high AUC to them.
So when you mix, I mean, I'm not saying this is the case, but hypothetically just took the math and said the units were flat. If you said that, if you just do it by dollars, you mix out on different AUC categories, you're going to get a natural blip. And those are categories we feel strongly about. You heard Sabrina touch on some of them. And denim in particular is a category we want to be very strong in Gap and in Old Navy, and pants, women's pants in particular at Banana Republic.
So as we figure those things out, made the decisions, we came to the conclusion we're going to make the right call for the customer. We're going to try to minimize the rest of the business, but we are following this path of making sure we don't have any negative aura anymore on our brands as being a brand that maybe cannot deliver on these needs.
Got it. Fair enough. Thanks.
Your next question is from the line of Dana Telsey with Telsey Advisory Group.
Good afternoon. With the solid start to the year that you have and what you had mentioned at
the beginning of the call, can you
expand on some of the key initiatives, for example, on the value proposition messaging? Does that mean adjusted opening price points or more promotions or the stepped up category strategies? Is that enhanced advertising for each brand? And then is consistency in delivery, what adjustments are being made to speed to market? Thank you.
I'll start with the value proposition. What I was trying to articulate is now a little bit of Jeff's question too. As we've worked hard in the business to say, where are we going to dominate and go after share, because I may have mentioned in a previous call, to have an arbitrary strategy says we're going to gain market share means, at least in my case, means nothing to me. It's what do we believe we can dominate on, what categories can we use to elevate the overall business by focusing on those. So hence from that you get what is the value proposition of the business and that is not necessarily strictly looking at opening price points and promotions, it might just be more about frequency, it might be more about how we actually speak to customers and all the different tools we have to communicate that this is great value.
I'll give you an extreme on the other side. Banana Republic is positioned the affordable luxury business. One of the tools they've just started using, I believe they should really step it up and I suspect Jack will do this, is inside their store they have a number of products they define every single month as the new price of luxury. So they're taking items that I think a lot of our customers who might go between some luxury brands or department stores and frequent different types of brands and value positioning within their sort of shopping habits, they're now looking at saying, well, if you know what a luxury item cost in key categories, what's a new price of luxury? How do we go out to them and take those buy into them, put a great price on it and actually show the value that Banana Republic brings?
So that's on the one side of the scale, people think about value proposition. They might always think about what does that mean in Old Navy in terms of hard nose aggressive everyday value pricing. That by the way happens to be true, but also across all of our businesses. How do when people come in knowing the customer we're going after, how do we define that value proposition for them, knowing that they frequent a number of different brands or different sectors with retail. So we've been working hard on that front.
In terms of speed to market, we've been making some steps, probably not enough to my satisfaction over the last 15 months to 18 months on the supply chain from the back door of the vendor to the back door of the store and then upstream from the design decisions from our teams in New York and here in San Francisco all the way to the actual placement of the PO. Over the last 6 months, we've made a lot more inroads on that front. Old Navy led it 2.5 years ago. Now we're seeing that Gap and Banana Republic and our outlet business and our online business and our global businesses have really adopted the fact that we need to become a lot faster, much more nimble. And some of those benefits we hope to get in the Q4 of this year, but there is a bit of a mind shift going on that we can do this to working with our existing vendors and fashion.
That speed is a process. Your aesthetic is your aesthetic. And I believe that everybody is Your aesthetic is your aesthetic. And I believe that everybody here, in fairness to them, not that we didn't have a lot going on in the last couple of years trying to steward the business to where it is today, but now that we're in a different place, we believe we can take on this initiative and work it into each one of our brands over the next number of months years.
Thank you.
Your next question is from the line of Jeff Klinefelter with Piper Jaffray.
Yes, thank you. Glenn, in terms of the
store rationalization work and consolidation that you're doing, you articulated the strategy a couple of years ago very clearly and have been making some progress. It sounds like you'll be making you'll be accelerating that progress going forward. And I was just curious if you have any examples to share evidence of the productivity improvements and how this is working as you go through the various formats nationally?
I'd say the biggest improvement we've made in the last 12 months is now that we know what our new prototypes look like, because prior to this, Jeff, when I explained it, it was sort of a real estate strategy drove the decision from the 40,000,000 square feet, that famous 40,000,000 square feet we talked about 2 years ago and how we're going to rationalize it in terms of what is the right number of stores per market that cover that target consumer and what are the prototypical square footages we want in each one of our brands. What we weren't talking about as much a few years ago is now we introduced these new prototypes. So I'd say the change for this year is that as the real estate team and you're right to say, I've actually been impressed, they've gained quite a bit of traction. Now the wind has been at our back given who we are, our size, our multiple brands and the fact that there's clearly an excess of square footage out there when it comes to landlords and different types of storefronts that we can consider for our brands. And there's less and less new entries and new retailers and competitors who are announcing massive investments in their store model and their capital programs, we're well positioned and I've seen great evidence particularly at Old Navy where we've gone out, we've either relocated across the street or been able to negotiate a reduction in space, get great terms from landlords in terms of the capital costs and get great terms in terms of putting our new model into that store.
And I think part of that has been that we're one of the few people, not the only company, we're one of the few people right now who are willing to put capital because we have a plan, we have a strategy, we've tested these new prototypes and we know we get the return we need and we're now stepping up as you saw with the Old Navy business, stepping up the amount of remodels we're doing. Given that, that makes us pretty unique in the marketplace. We've been able to use that not only to the betterment of the store and for our customers and for growing our market share, but using that as a leverage point with landlords. So I think that's the new piece that's really led the real estate team to start achieving a greater level of success in 2010 than they had in 2,009.
So Glenn, would you just say that you see this accelerating in the next 2 to 3 years versus the last 2 in terms of net reductions of the footprint?
Jeff, that's a mixed bag. I would say to you the following. Definitely, I would say and there's an acceleration this year I'm seeing in terms of us achieving and making a further inroads into our real estate strategy. Now that doesn't only mean reductions. Some of our real estate strategy decisions are not only based on that sort of based on consolidations, but I am looking at it and saying in 20102011 we're really well positioned.
I'd say better than I would have told you 2 years ago to actually execute on it. And I'm hoping to your point be able to speed it up by at least a year, but time will tell if they just keep giving you an update on that. But I'm hoping with the inroads I've seen made so far this year that will bode well for an acceleration of it. It's a little too soon to tell.
Okay. Thank you.
Your next question is from the line of Edward Yruma with KeyBanc Capital Markets.
Hi, thanks very much and congratulations on a strong quarter. You were very aggressive with share repurchases in the quarter and I don't know that they out clipped free cash just by a touch in the quarter. How should we think about targeted cash levels and your interest in doing share repurchases going forward? Thanks.
I'll take that. So, yes, we absolutely there's no change at all in our commitment and our principle around cash distribution. So as you know, we target about $1,500,000,000 of cash we want to keep on the balance sheet. We were successful in generating a lot of free cash flow during 2,009 and we intend through our new authorization of $1,000,000,000 that we announced a few years ago or earlier this year continue our repurchase program. So we're pleased that we did almost $300,000,000 in Q1 and we have every intention of continuing throughout the year.
Thank you.
Your next question is from the line of Michelle Clark with Morgan Stanley.
Thank you. Good evening. Sabrina, quick one for you and then a follow-up for Glenn. Sabrina, can you quantify for us the in transit impact to inventory at the end of Q1? And then Glenn, you had mentioned in your prepared remarks the Old Navy assortment getting a little bit too broad and then needing to tighten that up.
Can you just give us some more color there in terms of what specifically you mean and then the opportunity go forward? Thank you.
Yes. I think it's fair to say, Michelle, that the in transit really is the primary overage from where we had thought we'd be. So it's definitely worth a couple of points of that inventory per square foot number. And again, it's driven by Old Navy in transit, them wanting to get more fresh goods into the stores sooner. That's where sort of the overage came in.
And on Old Navy, what I would say, Michelle, is that Tom and the team have been pursuing for the better part of the last year adding some new businesses into the four walls of Old Navy. So you have what's known as our Goga business, women's active, followed by our men's active business known as VTech. We've been putting in a lot more non apparel led by jewelry. And simultaneous to the and that's there's a number of other, say, there's the licensing business we've put in and kids and baby. There's a lot of new businesses and categories as Tom has been executing on his category management plans and strategies simultaneously to that, because after all it is only one store and one set of square footage, Tom was planning to reduce some of the CC counts in some other categories, and we're looking at and going, those are good categories for us, we're going to be in them, we're going to it's more of a complementary category than a dominant category.
And those a complementary category than a dominant category. And those 2 plans did not line up
at the same time, which is unfortunate. Tom is aware of it.
So it was a bit of a maybe a 6 month overlap that Tom is now dealing with. If you went into our stores in February, March April, I think the people who are close to our business, it probably would have been evident. But I suspect that Nancy and Tom, based on the work they've done, we'll have that completely corrected by July. It's not a big problem. It's just that it's tough for some of the key categories that you're putting in new ones or ones we've agreed are part of the future we do want to dominant on, tough for them to shine and tough for them to actually get the space they need to gain market share against our identified competition.
If these other categories that should be reduced in space a little bit and be a little less prominent position, the CC count doesn't come down on those correspondingly. So I would say a big deal, no. A disappointment, yes, but one that is easy to rectify and come July I think we'll be in exactly the place we want to be.
Great, thank you.
Your next question is from the line of Barbara Wyckoff of Jessup and Lamont Securities.
Hi, everyone. You're paying a lot of attention to the pants and jean categories in Gap. Are you doing anything to jump start the tops business? And by building bottoms inventory and intensification, will you throw off your historical balance of tops and bottoms? No, it's a happened was
when we relaunched denim in August, there was a lot of effort between Patrick and Mark and the team to really get that off the ground. There's a big focus on it. And I may have mentioned this at a previous call, I don't remember, but if I didn't, what I probably should have said was with that focus, there was a disproportionate amount of share of mind that went through it and I get that, a disproportionate amount of marketing dollars that went towards launching that, which again I support and understand. But the complementary work on the tops, which and therefore the split of business, the proportionality of sales between tops and the split of business, the proportionality of sales between tops and bottoms is something that's critical for the overall store to be successful. And that probably got a little lower than Mark is comfortable with in terms of the sales at the end of the day.
I think there's a little bit
of work being done right now. At the end of the day. I think there's a little bit of work being done right now in our stores. We go see the new floral products that we have, everything else. I think that that was the beginning of them attempting to correct that split inside the business.
But most importantly to Michelle's question earlier, as we have become more nimble and become faster, the big thing now is the gap under Pam Wallach's leadership has been able to move very quickly on a speed process in a process in a separate pipeline to bring in some tops much faster. I just heard the other day this mean that we were just add that come August when the denim anniversary happens and our marketing campaign hits on July 27 to talk about denim from last year's anniversary and take it to the next level, we will see this time a much better presentation and mix of tops and bottoms inside the store.
Great. Looking forward to it. Thank you.
Your next question is from the line of Marni Shapiro with The Retail Tracker.
Hey, guys. Congratulations on a great Q1 and good luck with summer. You've been doing some very interesting things marketing wise to your cardholders. Recently, I got a mailer every Wednesday, Gap Love Wednesday, and I know you're running a 10% off if you use your card. So I'm curious if you've increased these to promotions to the cardholders, if you've changed this up, are they working?
And is it specifically targeted, most of them seem to work in store only, is that purposefully or are you running separate ones for online?
I would say, Marni, that there are times there's a cross all channel deal with our private label credit card. That does happen. But you're right, your observation is correct. I'd say for the most part they're independent decisions and a lot of them focused inside the store. I mean, I'm sure you know this that we have all the data that shows that a private label credit card purchaser, not only in terms of their frequency, but their average trends, trumps a non cardholder by a significant amount.
And us, along with our credit card partner, using their information and their muscle and their experience and in some cases their marketing dollars, supported by the work we do internally. We've been probably shifting that a little bit at all brands to speak to that cardholder specifically. And what we do find is this without we want we as I say in politics, we want to have a big tent. We want to invite everybody inside to our stores and try to get new customers. But there's two sides to marketing.
There's the customer acquisition and then there's the strength in your strengths. And I think we probably have shifted a little more money towards holding on to the customers we have and trying to get a larger share of wallet from them as opposed to going after new customers. It's not a big shift, but given numbers, probably a 10% shift in our marketing efforts have gone towards that. It's probably why you've seen a step up to you if you're a cardholder and you have a Gap Old Navy Banana Card, we're speaking to you with a little more frequency and getting you to come in, probably give a little bit of a heads up in advance of going to markdowns, probably giving you a bit of an advance notice when new product comes in that you should come in first and giving you in this case 10% a little added incentive to drop by our stores. So I definitely I think it's the right strategy for now.
There may be a time that we choose to switch back to an equilibrium or to put more money into customer acquisition. But right now, we've been trying to get the bigger share of wallet of existing customers.
Well, I for one thing they're great and they're a nice surprise when you receive them. So congratulations and good luck.
Thanks, Mark.
Next question is from the line of Evren Kopelman with Wells Fargo Securities.
Great. Thank you. I had a question on the rod, given it's going to be a significant component of the margin improvement going forward. Can you talk about where maybe you don't want to talk about where it is as a percent of sales, but compared to history where it was this kind of the low level when it was a percent of sales, where are we? How many is it several 100 basis points?
I guess I'm trying to figure out what's the opportunity? Where can that go?
Yes. So one data point, Evren, is this comparison to 2,005, where we have deleveraged since then by about 250 basis points. So we have a really, really nice runway in terms of rent and occupancy. And as you know, not only does that come from increasing our sales per square foot, getting our productivity back, increasing top line, but also all of this work that the real estate team has been doing during the recession to really capture the opportunities, lock in some favorable rents, do some good deals. I mean, we really feel like we're positioning ourselves well in shrinking the square footage, getting rid of unproductive rent, locking in new favorable long term rent.
That combined with an increase in sales really gives us this nice opportunity with we definitely would like to head back toward those levels of leverage that we enjoyed just 4 years ago.
Great. Thank you.
Your next question is from the line of Paul Lejuez with Credit Suisse.
Hey, thanks. A question on the remodels at Old Navy. Glenn, what's your goal there? What kind of lift are you looking to get out of these remodels? And Sabrina, can you maybe share with us what sort of accelerated depreciation might have been included in that rod line this past quarter?
Thanks. Here's what I can tell you, Paul, that traditionally remodels for many retailers, I think that some of them are just barely successful. In some cases, people do it for brand enhancement and they don't necessarily do it because it's accretive to return on invested capital. As you know, last year we did 5 and they went quite well. Then we decided to really move forward and get to 50 very quickly.
And those 50 for us to make them turn around and do close to 200 in the first half of twenty ten should probably indicate to you that from my experience and definitely from Gap Inc. History that we had a bit of a tiger by the tail. And in fairness to the remodel, part of it is we hadn't done anything to the stores in 15 years. So when you do go in and you make quite a significant change, you see in those stores, it's quite a significant look and feel. The merchandise looks a lot different.
It's like I said in a call maybe a number of calls ago that we're probably 2 or 3 generations behind on Old Navy. So when you make this big shift from no effect to the look and feel and environment for 15 years and then do it, customers have really completely different feel, it's one of our advantages. It's the person come into our store, it's a completely different feel, it's one of our advantages. It's the personality of the brand, which I think we look at. I mean I was in 2 years ago at a bunch of Costco stores and they look way better than the Old Navy store.
And that's a game we can't win from an environment perspective. Now I think we've regained our advantage. So I think we feel actually pretty good about what Tom and the team have done. They've been smart, they've been strategic. The execution and the opening by the field leadership team at Old Navy have done a phenomenal job.
I'm out this weekend in stores with that team. I know there's another 50 or 60 that are having the grand openings this weekend. So a really good program so far that we're invigorated about.
Yes. And with regard to the amounts, we haven't specifically quantified them, Paul, but they definitely were occurring in Q1. You actually get a ramp up in Q2. Even though we did about 100 in Q1, as Glenn mentioned, most of those stores were opened at the very end of the quarter. So you do get some of the new depreciation of all the new fixturing and everything coming into Q2 that's going to impact Q2 Rod.
So both on the SG and A and also the SG and A preopening costs or not preopening, but marketing costs for the grand reopening are going to fall into Q2 more than Q1 for the bulk of those stores. That's why even though numerically we got 100 done in Q1, 80 more remodels to do in Q2, more of the expense falls both on the rod line and the SG and A line into Q2. And then of course, it's a one time fall off in the second half.
Thanks guys. Good luck.
Your next question is from the line of John Morris with Bank of Montreal.
Thanks. My congratulations, I want to add as well. Unless I missed it, I wanted to just get caught up with Sabrina on the SG and A. You guys were pretty well controlled in the quarter on the SG and A line. And I'm thinking from a full year basis, the full year guidance numbers assume the same kind of order of magnitude of SG and A up about mid single digits.
And within that, your marketing plan, the spend there, has that been the same for the full year, particularly as it relates to advertising spend?
Yes. So overall, John, our plan on SG and A is we're going to remain very disciplined in our base businesses and we intend to leverage when we're successful at increasing our sales. Nominal dollars, of course, are going to go up because as you know, about half of all of our SG and A is store related and a big chunk of that is variable to sales. But just as you saw in Q1, even though dollars went up $41,000,000 we leveraged. Now what we're flagging is the timing of these investments in growth may change quarter to quarter the profile.
But overall, we're looking to leverage SG and A on our base businesses and overall do very well and tightly for the full year even with our growth initiatives is the goal. With regard to marketing, we haven't been specific about the back half. Our plans are actually still being laid out, certainly for the Q4 and somewhat for the Q3. For the Q2, I'd say, directionally, it's probably going to feel like the first quarter. So we're going to continue to invest incrementally in Old Navy, driven primarily by the grand reopening of the remodels, where we do radio and we do some specific spend behind them.
And then also more investment behind athletic catalogs to get them out to more new customers, new customers. And then Piperline, you may have noticed we're doing a lot more print in Piperline to bring new customers onto the website.
Glenn, are you happy with the marketing direction? Any change in philosophy or has it been pretty consistent all the way through?
No, I think,
John, it all comes down to keep it fresh and obviously very happy with the creative platform that Tom and his team put forward last March. But having said that, we have a brand new CMO joining us in a few weeks and she's highly talented with a lot of experience. And I believe Amy is going to come in and probably not change anything with the platform, but maybe take it to the next level. There has been a little bit of innovative ideas coming out from our ad agency and the team that's currently there, which is also highly talented, the team that currently does the work. So I'm looking forward to Amy coming in and taking to the next level.
I'd say GAAP that they are and they will be taking the formula they put forward for 1969, which was not only the fact that it was a much more modern approach to marketing. I think that it had a definitely more of a sexy feel to it and what they did in the 1969 launch. They're using the medium they use, the way they really totally leveraged our store and our store team, you're going to see them do that much more going forward. We probably arguably should have brought that formula to the Springs marketing, we didn't. But when you compare them, the holiday work we did versus the 19 69 work we did, the 1969 work which was product specific in key categories, much more relevant to the consumer today, maybe I would argue to the lower end of our 25 to 35 year old range.
I think that that's a formula we're going see going forward. You'll definitely see a version of that for the anniversary of 1969 and on July 27, and you'll definitely see, and I saw it last week, a really cool way of doing it for black pants, which will be marketed at the end of August of this year. But in Republic, I think that Jack and Catherine and the team has done a great job on the marketing there. My overall feeling with them is that they're putting more money in store, which matters for that business. But in general, you heard my opening comments, I'm still looking for a step up.
We have a strategic advantage in the amount of marketing we spend per year, and I want to make sure that we make every dollar count. Great. Thanks. Good luck.
Operator, we have time for just one last question.
Yes, sir. Your final question is from the line of Lorraine Hutchinson with Bank of America Merrill Lynch. Thank you. Good afternoon. Glenn, have you had the opportunity to test some of the new black pant offerings and other low risk categories that you're talking about really stepping up the investment in?
And then also are you considering television for the relaunch of 1969 and the Black Pants initiative?
There will definitely be no television. I was just saying to John earlier that the formula on how we did, I'd say a big investment in the stores, in the windows inside the stores, giving actual funds to our stores to go out and get people to come in and get the trial going, adding more labor, creating denim experts like we did in 1969. Our field team did an excellent job of that. You're going to see plus then the marketing, the external marketing to draw attention, social media, the fashion magazines, this formula we've worked out, it's going to be tweaked. Obviously, this black pant is a different purchase.
But I think the team has taken that overall framework and applied it to black pants, therefore there will be no television. The testing, you
know what Lorraine, sometimes there's things we're testing and I agree
with that, sometimes you just got to say what we believe in this. And the test for me that was important is Patrick and Mark and Pam had a number of very important fashion editors to New York about 2 to 3 weeks ago, And my feedback that I got independently to a few other people was the same sort of feedback we received a year earlier when we did the 1969 denim, we brought them in and showed it to them and they tried it on was equal to the feedback we got in the Black Panther relaunch. So that made me feel very good. And look, I'm a big believer it's a big business and sometimes you got to test concepts and sometimes you just got to say, you know what, that's strategically correct, you've done it before, we're going to do it again, Let's just put it out there and make it happen. Okay.
Thank you.
Thanks everyone for joining us on the call today. As a reminder, our earnings press release which is available on gapinc.com contains a recap of the Q1 Q1 results and the forward looking guidance that was included in Sabrina's remarks. And as always, the Investor Relations team will be available after the call for further questions. Thank you.
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