The Gap, Inc. (NYSE:GAP) Q2 2024 Earnings Call Transcript

The Gap, Inc. (NYSE:GAP) Q2 2024 Earnings Call Transcript August 29, 2024

The Gap, Inc. beats earnings expectations. Reported EPS is $0.54, expectations were $0.39.

Whitney Notaro – Director, IR:

Richard Dickson – CEO:

Katrina O’Connell – CFO:

Robert Drbul – Guggenheim:

Alex Straton – Morgan Stanley:

Matthew Boss – JPMorgan:

Ike Boruchow – Wells Fargo:

Lorraine Hutchinson – Bank of America:

Adrienne Yih – Barclays:

Mark Altschwager – Baird:

Jonna Kim – TD Cowen:

Dana Telsey – Telsey Advisory Group:

Operator: Good afternoon, ladies and gentlemen, I would like to welcome everyone to the Gap Inc. Second Quarter 2024 Earnings Conference Call. At this time all participants are in a listen-only mode. [Operator Instructions]. I would now like to introduce your host, Whitney Notaro, Head of Investor Relations.

Whitney Notaro: Thank you, and good afternoon, everyone. Welcome to Gap, Inc.’s second quarter fiscal 2024 earnings conference call. Before we begin, I’d like to remind you that the information made available on this conference call contains forward-looking statements that are subject to risks that could cause our actual results to be materially different. For information on factors that could cause our actual results to differ materially from any forward-looking statements, please refer to the cautionary statements contained in our latest earnings release. The risk factors described in the company’s annual report on Form 10-K filed with the Securities and Exchange Commission on March 19, 2024, and any subsequent filings with the Securities and Exchange Commission, all of which are available on gapinc.com.

These forward-looking statements are based on information as of today, August 29, 2024, and we assume no obligation to publicly update or revise our forward-looking statements. Our latest earnings release and the accompanying materials available on gapinc.com also include descriptions and reconciliations of any financial measures not consistent with generally accepted accounting principles. Joining me on the call today are Chief Executive Officer, Richard Dickson; and Chief Financial Officer, Katrina O’Connell. With that, I’ll turn the call over to Richard.

Richard Dickson: Good afternoon, and thank you for joining us. Gap Inc. delivered another successful quarter that exceeded financial expectations and we gained market share for the sixth consecutive quarter in comparison to where we were only one year ago, we are in a stronger position across key metrics that matter, including net sales, margins and our cash position, and we’re making consistent progress in the reinvigoration of our brands. These results give me confidence that we are on our way to unlocking Gap Inc.’s full potential. On today’s call, I’ll provide an update on our second quarter performance and progress in the context of our four strategic priorities: maintaining and delivering financial and operational rigor, the reinvigoration of our brands, strengthening our operating platform and energizing our culture.

Then Katrina will walk you through our detailed financial results and share our outlook before we open the call for questions. Let’s start with financial and operational rigor. As we said in the first quarter, this is becoming the fabric of our work, which we will continue to reinforce through better processes and cultural accountability and a focus on effectiveness and efficiency. Gap Inc. net sales were up 5% in the second quarter, and comps were up 3%, reflecting our continued focus on this important priority. Old Navy posted comps up 5%, representing four consecutive quarters of positive growth. GAAP comps were up 3%, driven by five consecutive quarters of share gains. Banana Republic comps were flat as the brand continues to gain clarity on fixing the fundamentals.

And as planned, Athleta’s comps were down 4% as we lapped heavy discounting. We expanded gross margin by 500 basis points, with SG&A largely in line with our expectations, delivering operating income of $293 million and an operating margin of 7.9%, an increase of 490 basis points versus last year’s reported operating margin. EPS was $0.54, up from $0.32 of reported EPS in the second quarter of 2023. We are maintaining inventory discipline with Q2 levels down 5% year-over-year, and we ended the quarter with a strong cash balance of $2.1 billion and generated nearly $400 million in free cash flow. Turning to our next strategic priority. We remain focused on driving relevance and revenue by executing on our brand reinvigoration playbook, which I’ve referenced over the last few quarters.

We are building stronger brand identities, supported by trend-right products, amplified through more compelling storytelling with an innovative media mix that is translating to greater cultural relevance. We are working to provide our customers with a more engaging omnichannel experience and aim to execute with excellence. Each brand is at a different point in the process and I’m encouraged by the improvements we are driving across the portfolio. I’ll take you through how these elements are showing up at each one of our brands, starting with Old Navy. Over the past year, our operational rigor has enabled us to strengthen Old Navy’s foundation and brand identity. We are winning in key categories with more clarity in pricing and in-store navigation connecting our customers with products they want and compelling storytelling.

As a result, we are driving market share gains and positive comps. Our trend-right product is driving share growth in women’s, which is important as she is the gateway to the family. Our strategic pursuit to lead in the active category is paying off with sizable market share gains, and we are leading again with dresses as we regain the number one position in the category according to Circana. We also see an opportunity to lean further into denim with an expanded offering, a dynamic in-store and online experience, supported by a new campaign expressing our evolving brand identity work. Old Navy’s marketing is becoming more relevant as evidenced by the impact of the submarine campaign. This successful campaign featured Tracee Ellis Ross and Yara Shahidi, who exuded a carefree Spirit of Summer, dressed in on-brand stylish offerings, it was a great indication of our new and exciting creative for Old Navy.

We are a stronger Old Navy than we were a year ago, and we will continue to operate with this level of rigor as we execute our brand reinvigoration playbook. Now let’s turn to Gap. We are focused on reigniting Gap’s leadership in trend-right products and creative expression through big ideas and culturally relevant messaging, returning to our roots as a pop culture brand. While we’ve achieved great progress with five consecutive quarters of share gains for the brand and seven consecutive quarters of share gains in women’s, we continue to be relentlessly pursuing better. The response to our Linen Moves campaign has been fantastic as we’ve become a destination for linen. Our focus going forward is on repeating these types of creative expressions that leverage our heritage rooted in music and dance and declare a trend statement.

We’ve continued to extend our methodology through the Get Loose campaign that we launched last week featuring Troy Sevan and Dance Company, CDK, declaring Gap as the destination for the baggy and oversized trend. Building on our momentum and share gains in Kids, Gap recently launched one of the strongest back-to-school campaigns, we believe we have had in years. We are taking a more innovative approach to kids as we embrace a new media mix model focusing on driving kid demand through mom-approved messaging. Collaborations continue to amplify Gap. We were pleased with the strength of our Doen collaboration that drove relevance and revenue as well as frequency from loyal Gap customers. Our Mad Happy collaboration enabled us to broaden our reach to a new customer base and is generating notable buzz.

Gap, our namesake brand, embody symbolic cultural importance both internally and externally. We are excited to see the progress to date and believe we are well on our way to revitalizing this iconic American brand. Now let’s turn to Banana Republic. Here, we are focused on reestablishing this brand to thrive in the premium lifestyle space. We have more clarity around fixing the fundamentals with assortment architecture, pricing adjustments and operational improvements. There is still significant work to be done, but we are continuing to perform while we transform Banana Republic into a stronger brand. At this stage, we are encouraged to see more stability across our men’s business with improved depth of wardrobe and a more distinctive style.

We are working to win in women’s with better assortment planning, a focus on key items and improved fit. Across men’s and women’s, our customers continue to see more trend-right products through our BR Classics and finest fabrics. Our refreshed flagship Soho store opened in June and is an outstanding example of the brand’s new expression, celebrating the brand’s heritage with a modern point of view. And we are actively underway with the process to recruit the next leader for the brand. Shifting to Athleta. We are resetting the brand, which has significant growth potential and a distinct brand identity rooted in the Power of She. On the world stage in Paris, where the Power of She was prominently demonstrated the cultural relevance of the Athleta brand was proudly represented.

The athletes featured in our Anthem collection marketing campaign, including gold medalist, Simone Biles and Katie Ledecky who partner with Athleta, not only for the superior product, but for the celebration and empowerment of women that is core to our brand purpose. We are successfully broadening our customer base, seeing better sell-through at full price. Our marketing execution is gaining traction. Our inventory position is cleaner and fashion products are resonating, driven by new merchandising. We are gaining more confidence and excitement around the team’s work to unlock Athleta’s incredible growth potential. As we move past headwinds in the first half, we expect the brand to return to positive comps for the remainder of the year. Moving to the third strategic priority, our operating platform.

Last quarter, I spoke to you about opportunities to drive scale and efficiencies across our organization and to better support our brands through platform functions, including media and technology. In Q3, we have begun working with our new media agency partner, Omnicom and are modernizing our capabilities. In addition to gaining leverage from this new partnership, we are excited about the opportunity for our media mix to become a growth engine for our brands over time. We are evolving from a promotional media mix focused on performance to a full funnel strategy in order to be more effective with our marketing spend. We are focused on becoming more consumer-led using data and optimization to a higher degree and implementing best practices in our execution.

This is a game-changing endeavor. We are early in our execution, but believe this will improve the economics of our marketing spend and change how we show up to our consumer. In terms of technology. During the quarter, we announced Sven Gerjets, as Chief Technology Officer, recognizing the central and growing importance of digital in our business and for our customers. It’s important that we move quickly to a way of thinking and working with technology embedded at our core to drive value, solve problems and serve our customers. We are evaluating and assessing our infrastructure, talent and capabilities as we focus on becoming a digital-first high-performing apparel company. Now turning to our fourth strategic priority, energizing our culture.

A great strategy can only go so far without a culture that is united and mobilized behind it. So I’ve been highly focused on this priority and intentional about visiting stores across the country to engage, listen and learn from our store associates and the customers we serve and to reinforce that every store matters and every person matters. In April, we introduced our new vision, mission, purpose and values, which have begun to unify our culture and set a standard for how we work. We believe we have a shared responsibility to our customers’ communities and each other to work with purpose and center our values in everything we do. When expressed consistently, this is what will energize and define our culture, our company, our brand. Our people are the gateway to the relentless pursuit of becoming better, and this work is central to the path we’re on to achieve our vision.

Last August, in my first remarks to you as CEO, I told you that I was intent on leading an exciting new chapter for Gap Inc., one that celebrates our past as we pioneer an extraordinary future. The potential of our brand portfolio was clear to me as was the need to reposition the company for sustainable, profitable growth. Since then, we’ve defined our strategic priorities, including our brand reintegration playbook. We have introduced a new sense of clarity that is empowering our people, helping attract world-class talent and partners and we have driven meaningful financial progress. To be clear, we have work to do because transformation of this scale takes time, but we are on our way, as our teams rise to the occasion, our Q2 results are yet another proof point.

And finally, I’d like to take a moment to recognize our global team for their dedication and hard work. They epitomize the very best of Gap Inc. as we continue our journey to unlock the full potential of this extraordinary portfolio. I’ll now turn the call to Katrina for a closer look at our financials.

Katrina O’Connell: Thank you, Richard, and thanks, everyone, for joining us this afternoon. We are pleased to report second quarter results ahead of our expectations with another quarter of positive sales growth and market share gains. In addition, we remained focused on the discipline we’ve created around margin expansion, expense and inventory management and maintaining a strong balance sheet, which resulted in further operating profit expansion and strong free cash flow. As Richard mentioned, the rigor we’ve developed is becoming core to how we operate and is enabling us to perform as we transform. Some key highlights from the second quarter include the following: net sales and comparable sales were up 5% and 3%, respectively, with continued strength at Old Navy and Gap, stabilized sales at Banana Republic and performance in line with our expectations at Athleta.

We delivered approximately 500 basis points of gross margin expansion and managed SG&A dollars roughly in line with our expectations. This resulted in an operating margin of 7.9% for Q2, a 490 basis point improvement versus last year’s reported operating margin. And we ended the quarter with $2.1 billion of cash, cash equivalents and short-term investments on the balance sheet and generated nearly $400 million in free cash flow year-to-date. The progress we’ve continued to make on our four strategic priorities is driving consistency in our results and sets a strong foundation to deliver long-term shareholder value. The continued strength in our performance is giving us the confidence to reaffirm our revenue and SG&A outlook for fiscal 2024 and raise our outlook for gross margin and operating income growth compared to our prior outlook.

Turning to the detailed results for the quarter. Net sales of $3.7 billion increased 5% versus last year, with comparable sales up 3%. Net sales growth in the quarter benefited from approximately 2 percentage points of incremental revenue that was specific to the second quarter and related to the structure of our credit card agreement. Additionally, the quarter benefited from approximately 1 point due to the weekly shift related to the 53rd week dynamic. By brand, starting with Old Navy, net sales were $2.1 billion, up 8% versus last year, with comparable sales up 5%. This represented the fourth consecutive quarter of positive comps at the brand with their continued focus on operational rigor and brand reinvigoration driving consistency and performance.

Turning to Gap brand. Net sales of $766 million were up 1% versus last year and comparable sales were up 3%. We are pleased to see that the recent brand reinvigoration efforts have resulted in positive comp sales for the last three quarters, driven by strong marketing and product execution. Banana Republic net sales of $479 million were flat year-over-year, with comparable sales also flat. As Richard mentioned, we are working to reestablish Banana Republic and improve the fundamentals of the brand. While it’s still early in the journey, we’re pleased by the progress as the brand continues to focus on execution. Athleta net sales of $338 million decreased 1% versus last year. Comparable sales were down 4%, which was in line with our expectations as the brand lapped the last of the prior year’s heavy discounting.

As the headwinds related to discounting diminish in the second half and progress continues as we fix the fundamentals, we expect Athleta to return to positive comps for the remainder of the year. Now turning to gross margin in the quarter. Gross margin of 42.6% expanded 500 basis points versus last year’s gross margin. Merchandise margin expanded 410 basis points with the remaining 90 basis points from ROD leverage. The merchandise margin expansion was driven by an estimated 170 basis points of lower commodity costs which was modestly below our prior expectation due to higher airfreight utilized to navigate supply chain congestion. The remaining 240 basis points were driven by higher sales from the incremental credit card revenue and improved promotional activity.

Now let me turn to SG&A. SG&A was $1.3 billion in the quarter, roughly in line with our prior outlook. SG&A as a percentage of net sales was 34.7%, deleveraging 10 basis points versus last year’s reported rate and 50 basis points versus last year’s adjusted rate primarily due to the timing of incentive compensation accruals. Second quarter operating margin of 7.9% improved 490 basis points compared to last year’s reported operating margin and 450 basis points versus last year’s adjusted operating margin. Earnings per share in the quarter were $0.54, up 69% versus last year’s reported earnings per share of $0.32 and up 59% versus last year’s adjusted earnings per share of $0.34. Now turning to the balance sheet and cash flow. We maintained disciplined inventory management ending Q2 with levels down 5% year-over-year.

We remain confident that we will maintain this discipline in Q3 with inventory expected to be down low single digits versus last year. As I mentioned earlier, we ended the quarter with cash, cash equivalents and short-term investments of $2.1 billion, an increase of 59% from last year. Net cash from operating activities was $579 million year-to-date driven by higher operating profit. And our free cash flow of $397 million year-to-date demonstrates the rigor we have put into managing the business. We remain committed to delivering an attractive quarterly dividend as a core component of total shareholder returns. During the quarter, we paid a dividend of $0.15 per share. Year-to-date, we will have returned $112 million to shareholders in the form of dividends.

On August 13, our Board approved maintaining that $0.15 dividend for the third quarter of fiscal 2024. As I reflect on our second quarter results, I’m encouraged by the consistency we’re seeing in our financial performance, enabled by continued focus, discipline and rigor across our organization. This consistency begins to put us on the path to becoming a high-performing company. Now let me provide some details on our updated outlook, starting with full year 2024. Our strong second quarter results give us the confidence to reaffirm our revenue and SG&A outlook for fiscal 2024 and raise our outlook for gross margin and operating income growth compared to our prior outlook. Regarding fiscal 2024 revenue, we continue to expect full year net sales to be up slightly year-over-year, excluding the 53rd week.

Our underlying assumptions related to the 53rd week, which I will describe in more detail in a moment, remain unchanged. While the global economic environment and consumer dynamics remain fluid, our general view of the consumer and macroeconomic conditions largely remain the same. We have deep confidence in the work our teams are doing and are focused on executing with excellence in the back half as we lap tougher revenue compares as a result of early reinvigoration efforts, particularly at Old Navy. As a reminder, 2024 is a 52-week year, but will be compared in total to a 53-week year in 2023. To reiterate, the loss of the 53rd week results in a detrimental impact of approximately $160 million to fiscal 2024 net sales. And I would like to provide more detail on the impact of the quarterly cadence of net sales in the year.

As a reminder, the first quarter 2024 net sales benefited by approximately 2 percentage points and the second quarter net sales benefited by approximately 1 percentage point compared to last year due to the timing shifts associated with the loss of the 53rd week. We expect the third quarter to also benefit by approximately 1 percentage point due to shifts in timing. We expect net sales in the fourth quarter to have a negative impact of approximately 7 percentage points or $300 million compared to last year due to both the timing shift as well as the loss of the 53rd week. We also expect approximately 1 percentage point of ROD deleverage in the fourth quarter due to the lower sales volume. Moving to gross margin. We have raised our outlook and now expect gross margin expansion of approximately 200 basis points for the full year compared to fiscal 2023’s gross margin of 38.8%.

Our gross margin outlook contemplates the following factors: we continue to expect the commodity cost tailwinds in the first half to become largely neutral in the second half of the year, resulting in approximately 100 basis points of benefit from commodity costs for the full year. The rigor we’ve utilized to manage inventories with discipline is expected to deliver the balance of the gross margin expansion versus last year, and we expect ROD as a percentage of sales to be relatively neutral on a year-over-year basis. Regarding SG&A, we continue to expect full year SG&A of approximately $5.1 billion with roughly $1.3 billion expected in Q3 and Q4, respectively. We are actively focused on cost efficiency. Our full year 2024 SG&A outlook reflects the substantial savings actions we’ve taken over the last 18 months, which are expected to result in lower spend and increased leverage year-over-year, demonstrating our expense focus and rigor.

That said, we acknowledge that our annual expense rate to sales is still higher than our aspiration and we are deeply engaged in identifying the next phase of savings to drive value creation over the long term. We are raising our full year 2024 operating income growth outlook to be in the mid-to high 50% growth range compared to last year’s adjusted operating income of $606 million. This represents significant progress towards returning to historical operating profit levels over time. Now let me share some additional color on our outlook for the third quarter of fiscal 2024. We are pleased with trends quarter-to-date and are planning for net sales in Q3 to be up slightly versus last year. As it relates to third quarter gross margin, we expect approximately 50 to 75 basis points of improvement versus last year’s gross margin of 41.3% primarily related to lower promotional activity.

As I mentioned, in the third quarter, we expect SG&A to be approximately $1.3 billion. In closing, we were pleased to deliver another quarter of strong financial results. The financial and operational rigor that we’ve worked to develop and will continue to pursue is enabling us to focus on reinvigorating our brands with the goal of generating sustainable profitable growth and delivering value for our shareholders over the long term. Transformations like this take time, and each of our brands is in a different stage, but the progress is encouraging, and we continue to lay the groundwork for the next chapter. With that, we’ll open the line for questions. Operator?

Operator: Thank you. Ladies and gentlemen, I will now hand it over to Whitney Notaro, before moving into the question-and-answer session.

Whitney Notaro: Before we open it up for Q&A, I want to briefly address the earlier-than-planned posting of our Q2 financial results to our website this morning, which is due to an administrative error. As soon as we saw the error, we immediately rectified it and notified the NYSE. We issued our earnings press release as promptly as possible rather than waiting until after the market closed to ensure widespread access to our results. With that, I’ll turn it over to Richard and Katrina to begin the Q&A session. Operator?

Q&A Session

Operator: [Operator Instructions] Our first question will come from Bob Drbul with Guggenheim. Please go ahead.

Robert Drbul : Hi, good afternoon. And just on the morning release, a little bit earlier at an 8:30 call, I think, would work for many of us. So — just an observation. Two questions, if I could. The first one is, Richard, can you just talk to whether the momentum at Gap brand and Old Navy can continue? And then the second one is, can you guys address just back-to-school trends so far? Thank you very much.

Richard Dickson: Yes. Thanks, Bob. First off, in general, we had another successful quarter. We exceeded our expectations, net sales up 5%. That’s great growth, especially when you consider we’re operating on 5% less inventory, 500 basis points of gross margin expansion, and we also expanded operating margin by 490 basis points. Important to note also, this was our sixth consecutive quarter that we grew market share. It’s a real indication that customers are responding well to our brand reinvigoration efforts. As you asked, Old Navy and Gap in particular, each of them posted quarterly positive comps, and it’s a real demonstration of the continued consistency in the results that these brands are showing up with. On Old Navy, we saw a particular strength in women’s as the team is really focusing on reasserting Old Navy style authority, and we’re dialing up fashion.

We’re also seeing broad strength across important categories: denim, dresses, kids and baby. Our marketing is resonating much more clear on our pricing strategy in-store navigation. There’s certainly compelling storytelling. Team is doing a great job executing with excellence, and we are going to be continuing to deliver consistent results. As it relates to Gap, similar story. We’re building on the success of our Linen campaign that we really were incredibly excited about. This is about relentless repetition. You’ll see that in our Get Loose campaign, which just launched last week. We’re declaring Gap as the destination for the baggy and oversized trend. We’ve had terrific results from collaborations like Doen and Mad Happy collaborations will also remain a key part of the strategy to broaden reach, strength and relevance and we’ll be sharing more collaboration news shortly.

But I’m very excited with the progress to date. Again, team is executing really well, and we’re on our way to revitalizing this iconic brand. Bob, your question on back-to-school, which clearly is — obviously, we’re in the throes of it right now. Hopefully, you’ve seen the advertising that we have this year with some great product, Old Navy and Gap launched a great marketing campaign that was primarily grounded in our brand reinvigoration playbook. We are very pleased with early results. I would say denim is having a moment in kids as well as adult, trends like loose fit, wide leg, fleece, classics, always — back-to-school, cargo, khakis are always in style. Most importantly, recognizing that Old Navy is the number 1 kids and baby brand in the U.S. The overall market was up about 5% in the quarter, and we gained share in both Old Navy and Gap.

So I think we believe we have an opportunity to accelerate in the kids and baby space, become an even more important player and you’ll see that as the quarters roll by. But anyway, thank you for the question. Pretty comprehensive on Gap and Old Navy and clearly, we’re in the throes of back-to-school.

Operator: Our next question comes from Alex Straton with Morgan Stanley. Please go ahead.

Alex Straton : Great. Thanks a lot for taking the questions. Congrats on a great quarter. Maybe one for Katrina and then one for Richard. So Katrina, I’m just trying to understand the third quarter guidance on sales. I think it’s just up slightly, which seems to be like a bit of a slowdown from the second quarter level. So can you just kind of give some color around what’s driving that guide by banner, maybe what you’re seeing so far? And then just for Richard, on Athleta, this return to positive comp growth for the rest of the year. Can you talk about where that brand is at in its transformation story? I feel like it’s a big margin lever. So I’m just curious kind of how you’re feeling there? Thanks a lot.

Katrina O’Connell: Yes, sure. So I’ll take the first one, Alex. I’m really glad you asked this. There’s a few drivers. First of all, I would start by saying we’re very confident in the brand reinvigoration work that we’re doing but we remain balanced in our view of the consumer as well as the macroeconomic environment in which we operate as we head into the second half of the year. I think more specifically and to get into more detail, just a reminder, we did experience about 2 percentage points of incremental sales growth year-over-year from the credit card agreement that was specific to Q2. Second, we do begin to lap our better performance from the early reinvigoration efforts in the third quarter at Old Navy in particular.

And then third, while we expect to return to positive comps, as we said at Athleta, the magnitude of the third quarter recovery has a range of outcomes. So we’ll see where that lands. And then year-to-date, as we talk about sort of comments by brand, we’ve seen really strong performance at Old Navy and Gap. And I think, as I just said, we are lapping some of those reinvigoration efforts in Q3. Banana is focused on fixing the fundamentals. We talked about that. And I think I’ll let Richard talk a little bit about as we exit lapping this highly promotional environment, how we’re feeling about Athleta.

Richard Dickson: Yes. Thanks, Alex. We’re gaining much more confidence in Athleta as net sales in the quarter were down 1%, comps down 4%, but really important to remind that we’re lapping a period of very heavy discounting last year, and there is a lot of good progress being made. We’ve successfully broadened our consumer base. We’re seeing much better sell-throughs at full price. Our marketing, which has been totally refreshed is gaining traction, and most importantly, our fashion product is resonating. And given the success that we’re seeing with our new product, notably in core bottoms and the limited edition drops that we’ve been doing, we now expect to see positive comps for the remainder of the year. The team has been focused on resetting the brand and setting the brand up for sustainable growth in the long term, and we’re very excited about the progress and the future of the brand.

Operator: Our next question comes from Matthew Boss with JPMorgan. Please go ahead.

Matthew Boss : Great, thanks. So Richard, on your targeted consistency, can you elaborate on maybe the structural changes that you’ve made across merchandising and marketing at Old Navy and the Gap that you see driving sustainable, profitable growth in the back half and then into next year?

Richard Dickson: Thanks, Matt. I would focus our answer to that on our strategic priorities. We have been incredibly disciplined in maintaining focus around our four strategic priorities and the execution of that, I believe, is really showing up in the metrics that matter. Maintaining financial and operational rigor, as I’ve said in my opening remarks, is really becoming the way in which we work better processes, much more cultural accountability. And again, as you see the performance that we have in the quarter and consistently, it’s really due in the context of how we’re working with much more disciplined process. That is really enabling the second priority, which is reinvigorating our brands. We’ve spoken a lot about our playbook and ultimately driving relevance and revenue to be on this journey to become a high-performing house of iconic brands that really shape culture.

Our two biggest brands, which we’ve noted, Old Navy and Gap are furthest along multiple quarters of positive comps and market share gains. And I’m encouraged, as I’ve said, with the improvements that we’re making on Banana and Athleta. The third piece, strengthening our platform. We’ve talked a lot about the greater value of our capabilities and leverage that we have to drive individual brand growth. A particular note, I mentioned our new media partner, Omnicom, it’s going to help us really drive efficiencies and effectiveness and amplify these brand narratives and become a strategic differentiator as we drive more culturally relevant conversations and a much more innovative media mix. Those examples will start to really show up in the second half.

And then the last piece I’d talk about is our culture. We’re seeing really strong signs across our organization and notably in our recent employee survey, which received nearly twice the engagement that we had compared to last year. I talk often about our people and our talent. They’re really the gateway to the pursuit of our vision and ultimately really driving better work and we’re working as a company around new values, new vision, new mission. We’ve added with precision, new talent. There’s extraordinary talent within the company. And together, that mix is really driving executing with excellence. So all in all, I’m very pleased with the progress. We have a lot more work to do, but teams are really focused on executing and certainly this quarter shows up on the scoreboard.

Matthew Boss: That’s great. Maybe Katrina, to that point, could you elaborate on just further areas of potential efficiency across the expense structure? Or just help best to rank multiyear leverage opportunity across whether it’s technology, marketing or corporate?

Katrina O’Connell: Yes. Thanks for that question. So after the last two years or over the last two years, we’ve really worked on increasing the financial rigor as we’ve talked about. We’ve actioned about $550 million in cost reductions. We know that the $5.1 billion of SG&A that we guided to this year does reflect lower nominal dollars versus last year and is leveraging, and that’s all despite higher incentive compensation accruals. So we’re pleased with the progress. But as you say, we do realize that SG&A as a percentage is still high. And we believe our cost structure can become more efficient. So we’re deeply engaged in identifying the next phase of savings to drive value creation over the long term. So we look forward to getting back to you when we have a more articulated plan, but we are deeply focused on efficiencies for the future.

Operator: Our next question comes from Ike Boruchow with Wells Fargo. Please go ahead.

Ike Boruchow : Hey everyone, congrats. I guess I’ll take Bob’s question, just take it a little bit more detail just because I know the ships are in there, and it’s a little hard to tell. But Richard, can you say specifically now that you have the tougher compares coming up specifically at Old Navy, do you expect Old Navy to continue to comp positively? And do you expect the company to continue to comp positively as we get into the back half? And then a follow-up question for Katrina. Just on the ROD line, you can see with the operating lease costs and the rent costs, those continue to go up by a decent amount, but the ROD dollars are going down and you’re getting good leverage. What exactly is going on, on the occupancy line that you guys have done to create a more leverageable model and how sustainable is that? Thanks.

Katrina O’Connell: Yes. So I’m happy to talk more specifically to the comp in the back half. So we did guide to sales in the Q3 time frame, up slightly. What I would say in general is, I would think about a spread that is sort of relatively neutral. So we’ll let you do the math on whether or not that means positive comps. But particular to Old Navy, and Gap, we feel very good about where we are in the brand reinvigoration process. And I think as Richard said, there’s lots of really exciting things happening from a product and marketing standpoint as we head into the back half, they’ve been most consistent in their performance. So we’ll see where that lands us, but we feel very good about those two brands. As it relates to ROD, right now, ROD leverages on about flat to modestly positive sales growth.

And as you know, we’ve done a lot of work in the store part of the business where we’ve closed over 350 stores as we went through the pandemic, primarily at Gap, and that has given us a lot more flexibility in that line to save not only rent and occupancy dollars but to get leverage on much lower sales. So that’s been a real benefit.

Operator: Our next question comes from Lorraine Hutchinson with Bank of America Global Research. Please go ahead.

Lorraine Hutchinson : Thank you. Good afternoon. I just wanted to focus on Old Navy for a minute and the profitability, where do you see the largest opportunities to improve margins at Old Navy? And is this one of your key goals in terms of improving consistency?

Katrina O’Connell: I’ll start and Richard can pile on. I think in general, the rigor that we’re putting in place across the company around inventory management, expanding gross margins being prudent about SG&A and overall growing operating margins, I think, is leading us to impact all of our brands. So we’re focused on driving profitability across our portfolio. Old Navy, obviously, is the biggest brand in the portfolio is quite important on that journey. I think overall, when you look at the company and you think about the guidance that we put out, our gross margins for the year are approaching historical highs. And so we feel very good that we’ve made a lot of progress around gross margins for the company. And our bigger focus, I think we talked about just a minute ago is really turning our attention to further work we can do around the expense structure of the company.

Richard Dickson: Lorraine, I’ll just add, we’re running a fundamentally stronger business. And obviously, the metrics that we’re posting are indicative of the efforts that we’ve been making. But of particular note, we’re driving a 5% net sales growth on 5% less inventory. We’ve been working on our inventory and inventory management for quite some time as the composition that we have is much stronger. We have better product better sell-through in general at full price and therefore, less discounting. And obviously, the impact on margin is there. As we continue to drive consistent deliverables on Old Navy, Gap and across our portfolio, we expect that type of rigor to remain consistent. This is our fourth consecutive quarter of positive comps for Old Navy.

It’s the sixth consecutive quarter of market share gains as well for Old Navy and for the company. Again, as a reminder, it’s also the seventh consecutive quarter of women’s gained share in Gap. So consistently doing what we say we’re going to do driving leaner, more inventory that is precise and better storytelling, and we’re getting that resonance with consumers.

Operator: Our next question comes from Adrienne Yih with Barclays. Please go ahead.

Adrienne Yih : Great, thank you. Congratulations on the progress. Richard, I can appreciate very much the market share gains at the Gap brand. I was wondering after a year with the comp over a year, can you talk about kind of the descriptors for what is the core target demographic, the core market for Gap? Because I feel like that is the one brand that maybe has moved around a bit over the past decade. And then secondly, Katrina, just some clarification on the onetime benefit of the credit card revenue, 2 percentage points to sales, but you said, I think you said 240 basis points on the merch margin. So should we just net — should we take that out of the operating margin and think about it that way for an adjusted basis? Thank you.

Richard Dickson: Thanks, Adrienne, for the question. And in particular, on the Gap brand, which we’re so proud of the progress that we made. And as I mentioned, I really do believe we’re well on our way to revitalizing this iconic American brand. It’s also important to note, the brand is 55 years old or young. We just celebrated our 55th anniversary. And I think in the context of what that represents, it’s a multigenerational brand. And we’ve been focusing on returning to our roots as a pop culture brand. And so trend-right products and creative expression that is supported by big ideas and culturally relevant messaging. It’s less about age and more about brand persona and brand identity. And I’ve been really pleased that the brand has delivered these consistent results in the quarter.

Net sales up 1%, comps up 3%, gaining market share for the fifth consecutive quarter across women’s, men’s, kids and baby. These are real indications that we’re starting to get it right. Our Get Loose campaign, which is out there now just launched last week, it’s a declaration as gap as a destination for trend, baggy and oversized trend. But when you talk to different consumers in different age brackets, they’re all really enthusiastically excited about Gap narrative and about where we can potentially go with this brand and its heritage. As mentioned again, the collaborations, Doen, Mad Happy, it’s a key part of our brand strategy. It’s broadening our reach. It’s strengthening our cultural relevance. It’s opening up consideration for generations that might not have considered Gap.

So it’s a multi-tiered approach. I’m very confident in how the progress is delivering to date, and there’s a lot more to share in the future.

Adrienne Yih: Super helpful.

Katrina O’Connell: Sure. As it relates to the credit card benefit, yes, so it was about 2 points to net sales year-over-year, and that was driven by incremental revenue related to the credit card agreement. And it was basically we have contract provisions within the arrangement of our credit card agreement that impacts the timing of how we recognize certain revenue. So it was unique to the quarter. As it relates to the margin piece, however, we did break down the merch margin into 410 basis points of benefit. We said 170 was commodities and 240 is actually about half the credit card dynamic and the other half is actually better promotional performance. So I wouldn’t take all of that too far out. You can use about half as an example to adjust for that onetime benefit.

Adrienne Yih: Okay. Thank you so much, I appreciated. Best of luck for the holidays.

Operator: Our next question comes from Mark Altschwager with Baird. Please go ahead.

Mark Altschwager : Good afternoon. Thank you for taking my question. So we look across the apparel space here, we’ve seen several examples in the last couple of months about how value is really taking share with consumers in this backdrop. Old Navy clearly known for value, well positioned there. So I was wondering if you could just sort of speak to your opportunity to lean into that over holiday with your marketing messaging. And just also, what are your expectations more broadly for the promotional backdrop for the holiday season? Thank you.

Richard Dickson: Thanks, Mark. As far as we’re concerned, we haven’t seen anything that would warrant any changes or new factors that are influencing our outlook for the year. As always, our job is to create the interest in demand and capture consumers’ attention. And we’ve been really encouraged specifically to see growth across all income cohorts. That’s really a reflection of the strong value proposition across all our brands, not just Old Navy. Traffic remained similar to last year, and our strength in the quarter is really been driven by the average transaction as customers are responding really well to our products. And customers react to newness, innovation and great storytelling. The apparel market, as you know, is down 2% in the quarter and Gap Inc.

and our brands gained share. And it was strengthening categories such as denim, active and kids and baby, which have been strategically really well intended. And it indicates that our reinvigoration is resonating with consumers. This conversation around trading down, we haven’t necessarily seen evidence of trade down. Customers are continuing to have positive response when they’re offered the right price at the right style at the right value equation. Our portfolio, we believe, is really well positioned and particularly with Old Navy as the largest brand in the value space. And so if there is a flight to value, Old Navy is there with a welcome mat.

Operator: Our next question comes from Jonna Kim with TD Cowen. Please go ahead.

Jonna Kim : Thanks for taking my questions. I would love more color around how your promotional strategy now is structurally different from before and just related to merchandise margin, if we should start to see moderation in the promotional benefit and how we should think about that as we model as well? Thank you very much.

Katrina O’Connell: Yes, sure. So I think as we think about what’s happening in the industry overall, it appears the industry is controlling inventories well and generally, that helps make for a more rational promotional environment, I think more particularly to us, our inventory is well controlled, and we’re very focused on executing our reinvigoration playbook. Again, as we think about the second quarter we had very strong beats in gross margin. A portion of that driven by commodities. And as we just talked about, a portion of that driven by the credit card activity, but also by better performance in gross margin. As we think about the year-to-date performance for the company, we’ve gained about 450 basis points in gross margin overall due to a strong recovery in commodity costs as well as better inventory management.

So we feel very good about the progress that we are making in being able to control inventories, offer better assortments and really generate less promotional volume. I think in addition to that, we see continued benefits heading into Q3. We just provided an outlook that shows a range of possible outcomes around margin, which could grow somewhere in the 50 to 75 basis point range. And we attributed that upside to really improved promotional activity as we head into third quarter. So when you take the first half performance and our third quarter raised outlook, we’ve actually raised our full year outlook on gross margin again. And we now expect gross margins to be up about 200 basis points year-over-year. So all of that, I think, is a reflection of the rigor we’ve put into the inventory management side as well as the reinvigoration work that the brands are doing to offer great product at great value through great marketing.

Operator: Our next question comes from Corey Tarlowe with Jefferies. Please go ahead.

Corey Tarlowe: Great, thanks. Good afternoon, and thank you for taking the question. I wanted to ask about the right way to think about what the potential EBIT margin or profile of the business could be. Given I think this is the first time in the first half of the Gap’s fiscal year in a very long time, if ever, you’ve had gross margins average over 41%. So curious to hear how you think about the additional levers that you can pull to drive higher EBIT margins sustainably for longer?

Richard Dickson: First of all, I think we’re proving with the consistent deliverables quarter after quarter that we do what we say we’re going to do. This quarter, in particular, was a real success story in relation to 500 basis points of gross margin expansion, and of course, our operating margin expansion of 490 basis points. We’ve held our view on revenue and SG&A, and we’ve raised our guidance in relation to higher gross margin outlook. And we expect to expand roughly 200 basis points year-over-year for ’24, and that will result in EBIT growth in the mid-to high 50% range. As we continue to deliver against our priorities and over the long term, we’re working on multiple initiatives especially in the expense structure. And we’ll be getting back to you as to the targeted ways that we’re going to continue to drive efficiencies and effectiveness.

And as we continue to deliver what we say we’re going to deliver, we see the ability for this portfolio to deliver historical references and ultimately, new chapters of growth for the company.

Corey Tarlowe: Got it. And then just Katrina, as a follow-up to that, what’s the comfortable level of cash for Gap Inc. going forward?

Katrina O’Connell: Yes. Well, first of all, I would say we’re very pleased with the health of the balance sheet. $2.1 billion of cash is a meaningful growth year-over-year. And so that certainly feels good. I think about minimum cash balance is somewhere in the $1.2 billion range. That gives us a level that ensures we have the cash to service our working capital fluctuations and general business volatility. And then when I think about cash, we sort of have a balanced framework for capital allocation. First, we invest in the business through capital to the degree we feel like we can get a good return. And this year, we’ve said we’re spending about $500 million in capital. Second, we believe in paying an attractive dividend as a key component of shareholder returns and we have paid out about $112 million so far year-to-date, and we just approved another $0.15 a share dividend in third quarter.

So I think so far, we feel very good about the way we’ve been managing the balance sheet. And all of that management this year so far has given us about $400 million of free cash flow. So hopefully, that’s helpful.

Corey Tarlowe: Thank you very much and best of luck.

Operator: Our last question will come from the line of Dana Telsey with Telsey Advisory Group. Please go ahead.

Dana Telsey: Hi, good afternoon everyone. And very nice to see the progress. Richard, I’ve been in the stores in the new Banana Republic and Soho and in Century City that you just opened. And certainly, the physical store footprint is important for the new enhancements to the products that you’re advancing. How are you thinking about the retail fleet? In the past, it had been thought that Old Navy would go into some more rural areas, too. What’s the status of the fleet of each division? Were the remodel smaller size and where you’re taking it going forward? Thank you.

Richard Dickson: Thank you, Dana. I really appreciate you visiting our Soho store and Century City. We’re really proud of those expressions. And I think Soho and Century are great examples of immersive experiences that we’re trying to create. It certainly has a new aesthetic which we believe, again, has the right elements for the new direction that we’re taking, and we’re planning to roll out similar elements inspired by those two doors to the rest of the fleet. As it relates to retail stores in general across our fleet, we are in the sort of studying stage, if you will, of optimizing our retail footprint. There’s a lot of work that we’re doing to understand productivity, store experiences, traffic and all the variables, as you can imagine with a fleet and presence that we have we believe very strongly in retail and the balance of the omnichannel experience being both bricks and mortar and digital and the connection between the two, but we have work to do.

We have a lot of work to do across our fleets to make sure that these stores reflect the brand reinvigoration that we’ve been working on. Each one of our brand leaders is paying incredible attention to the store experience the service levels, the aesthetics, the sites, the sounds, these are all really important parts of our consumer journey and the reinvigoration of our brands. So while we made progress, and we’ve got some great indication on some of our stores. We do have a lot of work to do, and we’ll be sharing a lot more of that in the quarters to come.

Operator: Thank you. We’ve reached the end of the question-and-answer session. That does conclude our conference call. You may now disconnect.