GAP Q1 2024 Earnings Call Transcript

Quartr
Provided by Quartr
May 25, 2023

Key Takeaways

  • Gap Inc. delivered Q1 with 620 basis points of adjusted operating margin expansion, ended with 38% more cash versus last year, reduced inventory by 27%, and paid down $100 million of its asset‐backed loan.
  • The company flattened its organizational structure from 12 to 8 layers, increased average span of control, eliminated approximately 1,800 positions (~25% of HQ roles), and expects roughly $550 million of annualized savings from these changes.
  • Brand sales were mixed: Old Navy comps down 1% but gaining market share in women’s and baby; Gap brand comps up 1% with icons resonating; Banana Republic comps down 8%; and Athleta comps down 13% due to product acceptance challenges.
  • Gap Inc. is modernizing core capabilities by reestablishing merchandising processes, leveraging customer analytics, partnering with vendors to boost responsiveness, and has created a transformation office with incentives tied to cost‐reduction goals.
  • For Q2, the company expects net sales down mid‐to‐high single digits and adjusted SG&A of about $1.3 billion; full‐year 2023 net sales are projected down low‐to‐mid single digits, with gross margin aided by lower freight and improved promotional activity.
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Earnings Conference Call
GAP Q1 2024
00:00 / 00:00

There are 10 speakers on the call.

Operator

Afternoon, ladies and gentlemen. My name is Abby, and I will be your conference operator today. I would like to welcome everyone to the Gap Inc. First Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen only mode.

Operator

For those analysts who wish to participate in the question and answer session after the presentation. As a reminder, please limit your questions to 1 per participant. Followed by the 0 key on your touch tone phone. I would now like to introduce your host, Cameron McLaughlin, Head of Investor Relations.

Speaker 1

Good afternoon, everyone. Welcome to Gap Inc. Q1 fiscal 2023 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 as well as a description and reconciliation of any financial measures not consistent with generally accepted accounting principles, 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 ks filed with the Securities and Exchange Commission on March 14, 2023, and any subsequent filings with the Securities and Exchange Commission, all of which are available on gapbank.com.

Speaker 1

These forward looking statements are based on information as of today, May 25, 2023, and we assume no obligation to publicly update or revise our forward looking statements. Joining me on the call today are Interim Chief Executive Officer, Bobby Martin and Chief Financial Officer, Katrina O'Connell. With that, I'll turn the call over to Bobby.

Speaker 2

Thank you, Cameron, and good afternoon, everyone. Thanks for joining us today. Consistent with what you've heard from us Over the last few quarters, we continue to take the necessary actions to drive critical change at Gap Inc. To further improve the trajectory of our business execution and requiring a much deeper and integrated focus on the customer to unleash each brand's potential. Also simplifying our operating structure and model reducing costs, improving speed of decision making and unlocking our creative muscle, And modernizing our core capabilities that have been on Gap Inc.

Speaker 2

Roadmap for far too long. I understand that we have surfaced these issues before and what I would say is simply, this work has been derailed for pleased that our teams are embracing the work and behaviors needed to get us there. The leadership team is committed to getting the work done and have put structure, process and leadership accountability in place to ensure that we do. Now let me give you a little more specific

Speaker 3

insight to the actions that we have

Speaker 2

been taking. First, we took a 1st, we took immediate action to improve our near term execution and brand performance. We have moved quickly and effectively at clearing excess inventory, improving assortment, particularly The company delivered over 600 basis points of adjusted operating margin expansion compared to last year, driven by significantly improved gross margin from reduction of excess of air freight expense and improved promotional activity as well as adjusted SG and A leverage, And our balance sheet is stronger. We ended the Q1 with nearly 40% more cash than last year, almost 30% less inventory than last year and we paid off $100,000,000 of our outstanding ABL balance just last week, while also continuing to deliver an attractive quarterly dividend to our shareholders. Now let me speak to each of our brands.

Speaker 2

Starting with Old Navy, comparable sales were down 1%. Old Navy's momentum continued into the Q1 with market share gains driven by strength in women's as well as a reversal of trend in the baby business that was offset by softness in active and kids. The Old Navy team under IO Barbato's leadership remain focused on stabilizing the core and elevating execution which contributed to improved margins resulting from its leaner inventory position and balanced assortments. Styles with a clear fashion point of view and diversified end use like woven tops and pants performed well giving customers the option to go from casual to dressed up, thanks to outfitting cues focused on versatility. The team also continues to lean into its responsive capabilities in order to place inventory buys more efficiently and remain flexible to chase into demand or pivot if the customer needs shift.

Speaker 2

On Gap brand, comparable sales were up 1% driven by continued strength in women's, a modest improvement in baby and offset by weakness in kids and active. Gap brand's focus on amplifying its icons is truly resonating as the team focuses on reintroducing versions of its iconic styles. This shows up as updating styles like our women's silver faux leather jean, and on trend take on our classic Cheeky Straight denim offering. And I'm encouraged by product improvement in other categories as well, Including denim, woven tops and dresses which showed up with increased versatility. The team uses responsive levers adjacent to best selling women's denim like the baby boot and high rise stride as well as trending woven tops further driving growth in these categories.

Speaker 2

Moving to Banana Republic, comparable sales were down 8% on top of an outsized positive 27% comp last year. While still early on its journey Banana Republic continues to make progress establishing itself as a premium lifestyle brand and is resonating with our customers. This March, it unveiled VR home with a curated collection of rugs, bedding, decor and more, all capitalizing on the VR customers' appreciation for great style, design and quality and leveraging the deep home lifestyle talent and expertise of the Banana Republic leadership team, We look forward to more expanded collection in the future. And finally, Atlanta, which posted comparable sales of negative 13%, which were below planned for the quarter. As we discussed last quarter, Athleta's near term performance was negatively impacted by continued product acceptance challenges including color, print and pattern misses And from straying too far from its performance DNA.

Speaker 2

Delivering the best product for our customers is the highest priority and while the team is focused on making improvements in the assortment we know it will take time for those changes to fully take hold. While we continue our search for a new leader for Athleta, we are leveraging the great talent currently at the brand, including our new Chief Creative Officer, Julia Leach, as well as some of our best merchandising and product talent from across our portfolio of brands. Collectively, they are leaning in and improvements where we can, including better presentation of the product that is working and elevating our marketing and creative expression. And across Gap Inc. We are still watching the channel shifts closely.

Speaker 2

While online sales were down single digits in Q1, They are up close to 40% from pre pandemic levels in Q1 of 2019. As the consumer continues to shift back to stores, we remain focused on delivering the optimal omni experience for our customers across all brands and all channels. 2nd, we've made significant change to our organizational structure and are actively improving our operating model to unlock period of muscle, heighten accountability and empower talent by removing bureaucracy, Complexity and outdated processes while also reducing costs. These changes are pivotal and restoring our strengths and priority around design, innovation, style and trend. We flattened the organization by reducing layers from 12 to 8 and increasing the average span of control from 2 people to 4 still with the intent of getting to 5 or better informed by best in class benchmarks.

Speaker 2

All of this to address execution and efficiency and improve decision making quality and speed. Each of our brands now have consistent structures built around our product, our customer and our creative excellence with clear roadmaps and mandates. We believe this work will ultimately show up in improvements in our sales and margin performance over the long term and again most importantly in creative and product execution. Fundamental shifts included combining merchandising and inventory management under one leader to oversee the end to end process fueled by consumer insights, bringing channels together under the commerce and experience lead to drive omni thinking in the end to end consumer experience and splitting marketing leadership into 2 roles, one focused on creative and brand identity and one focused on execution and analytics. And we have also centralized G and A functions that were previously embedded in the brands to create efficiencies and better leverage the scale and expertise of our portfolio.

Speaker 2

These changes result in eliminating approximately 1800 positions and when combined with our earlier actions last fall reflect approximately 25% of our headquarter roles, A significant contributor to nearly $550,000,000 in estimated annualized savings on a cumulative basis. I know we all can understand. These decisions are always very, very difficult to make, especially when saying goodbye to team members that we care about. Beyond these organizational changes, the bigger payback will come when we show up as a more informed, faster and more creative company, delivering brand and cultural relevance to our customers. We have organized not just to improve the cost structure of this company, but with an eye toward best in class industry standards and setting ourselves up to deliver long term results.

Speaker 2

To be clear, this is not a one and done cost cutting exercise. We are after a mindset and cultural shift that will be part of our evolution as we go forward. The teams are now in place and in consistent pursuit of efficiency. We will continue to look at additional opportunities to rationalize our technology and marketing investments and exploring ways to further optimize our cost structure longer term. More to come as the team gets in deeper into this work.

Speaker 2

Thirdly, we are modernizing our capabilities to build a healthier company at the core and ultimately change the trajectory of our business. Through these improved capabilities, we are focused on key product to market functions, Including reestablishing core merchandising processes and pricing architectures, amplifying and leveraging customer insights and analytics, and leaning in further to our vendor partners in our product development processes as we further elevate our responsive capabilities. Lastly, to bring leadership, structure and accountability to ensure we drive this work to completion, we have put a transformation office in place Under the Gap Inc. Leadership team, and we've engaged external consulting partners to even further drive rigor, processes and day to day discipline to support the team through this period of significant change. We have also aligned a significant portion of our incentive compensation this year to the achievement and completion of our cost transformation efforts.

Speaker 2

Our leaders and our teams are committed to this change, and I'm proud of the progress today. And finally, before I turn the call to Trina, I want to address our CEO search and the comments made by our Lead Independent Director, Mayo Shattuck, in our earnings press release today. When I took the role of Interim CEO in July, I did not expect to still be speaking to you on our Q1 earnings call. But This only underscores how strongly the Board is committed to appointing the right person as our next CEO, one who has passion, strong vision and customer obsession that will take this company forward. We are deeply engaged toward the appointment and Look forward to the time we will introduce you to the new CEO of Gap Inc.

Speaker 2

Let me move us on, But I hope this provided a bit more clarity around our commitment to shoring up the foundation of this company for the long term by lowering our cost structure, Building a culture of creativity and empowerment and reorienting our business toward the customer. These types Katrina, I'll pass it over to you.

Speaker 4

Thank you, Bobby, and thanks everyone for joining us this afternoon. The actions we are taking to significantly reduce excess inventory, improve category and assortment balance, transform and optimize our operating structure and significantly reduce operating expenses, while further fortifying our balance sheet have allowed us to enter fiscal 2023 better position. During the Q1, We delivered net sales in line with our expectations driven by continued women's category strength at Gap and Old Navy despite the weaker sales at Athleta. Over 600 basis points of adjusted operating margin expansion as we drove down excessive air freight expense And delivered significantly improved promotional activity, most notably at Old Navy and leveraged adjusted SG and A. Reduced inventory down over 27% year over year, which was only up 3% versus Q1 2019 and ended the quarter with cash and equivalents up 38% from last year to nearly $1,200,000,000 While we believe we are making progress to better position our model to deliver for the long term, we continue to take a prudent approach in planning and managing our business in light of what continues to be an uncertain macro and consumer environment.

Speaker 4

We remain focused on the levers and opportunities in our control to deliver on behalf of our customers, employees and shareholders. Let me start now with our Q1 results. 1st quarter net sales of $3,300,000,000 decreased 6% versus last year and were consistent with our expectations for 1st quarter sales to be down mid single digits. As a reminder, the sale of Gap China at the beginning of the Q1 had a 2 point negative impact to net sales growth and there was also a 1 point foreign exchange headwind. Excluding Gap China sales of approximately $60,000,000 from Q1 last year and the foreign exchange headwind, Total company net sales would have been down 3%.

Speaker 4

Comparable sales were down 3% in the Q1. Store sales decreased 4% from the prior year. Online sales decreased 9% versus last year and were up 39% compared to pre pandemic levels in 2019. Online represented 37% of total sales in the Q1. Turning to sales by brand, Starting with Old Navy, sales in the Q1 of $1,800,000,000 were down 1% from last year.

Speaker 4

Compared to 2019, Old Navy sales were up 2% in the quarter. Although we believe Old Navy continues to experience demand softness from its lower income consumers, We're pleased to deliver 1st quarter comparable sales down 1%, which was a continued improvement from fiscal 2022, driven by strength in women's and a modest improvement in baby, offset by continued softness in active and kids. Old Navy continued to gain share in the quarter, driven largely by market share gains in women's and the kids and baby category. We continue to believe that Old Navy remains well positioned given its value positioning in the marketplace. Gap brand total sales were $692,000,000 excluding the 8 point negative impact related to the sale of Gap China, the 3 point negative impact from foreign exchange headwinds and the 1 point negative impact due to the shutdown of Yeezy Gap.

Speaker 4

Sales were down 1% versus last year, largely driven by store closures in North America. Gap Red comparable sales were up 1% driven by continued strength in women's, a modest improvement in baby, offset by continued weakness in active and kids. Gap brand continued to gain market share in women's as reinvented icons are resonating with consumers. Banana Republic sales were $432,000,000 in the Q1 with comparable sales down 8% on top of a positive 27% comp last year. While the transformation of BR into an elevated lifestyle brand continues to take hold and resonate, the brand is lapping outsized growth last year driven by post COVID shift in consumer preferences, which is impacting year over year growth.

Speaker 4

Athleta sales of $321,000,000 were down 11% from the prior year or an increase of 45% compared to 2019 pre pandemic levels. Comparable sales were down 13%. As we told you last quarter Athleta has had product acceptance challenges, which we believe are impacting results. While we know it will take at least a few quarters to make meaningful changes to the assortment, the team has been at work to improve product presentation and creative with an emphasis on the performance DNA that Athleta is known for. Now to gross margin in the Q1.

Speaker 4

Reported gross margin was 37.1%. Adjusted gross margin increased 570 basis points to 37.2%. Merchandise margin on an adjusted basis increased 6 10 basis points. This was driven by approximately 5 basis points of leverage as we lapped last year's elevated airfreight and drove our normalized air expense down. Approximately 3.30 basis points of deleverage due to inflationary cost headwinds as we are now selling product locked in at last year's peak cotton prices.

Speaker 4

This was slightly better than the 360 basis point headwind we anticipated as we are beginning to benefit from better ocean freights. And the remaining 380 basis points of leverage stemming primarily from improved promotional activity relative to last year primarily at Old Navy. ROD as a percentage of sales deleverage 40 basis points versus last here. Now let me turn to SG and A. Reported SG and A in the quarter was $1,200,000,000 including a $47,000,000 gain related to the sale of our 1 Harrison office building, offset by $71,000,000 in restructuring charges related to actions to optimize our operating structure, including the reduction of approximately 1800 corporate and upper field roles.

Speaker 4

As we discussed last quarter, the actions we are taking to optimize our operating model and structure are expected to result in annualized savings of $300,000,000 of which half we estimate to benefit SG and A in the second half of fiscal twenty twenty three and the remainder in the first half fiscal 2024. Adjusted SG and A of $1,200,000,000 was down 7% from last year. As a percentage of total sales, adjusted SG and A leveraged 60 basis points, driven by lower advertising expense and lower technology investments, resulting from our cost saving actions late last year. Reported operating income was a loss of $10,000,000 adjusted operating income, which excludes restructuring charges and the gain on sale was $18,000,000 in the Q1. Adjusted operating margin improved 620 basis points from last year to 0.5% in the quarter, driven by the 5 70 basis point improvement in adjusted gross margin and 60 basis points of adjusted SG and A leverage.

Speaker 4

Reported EPS was a loss of $0.05 Adjusted EPS, which excludes restructuring charges and the gain on sale was 0 point 0 $1 share count ended at 368,000,000 Turning to balance sheet and cash flow, starting with inventory. Ending inventories declined 27% in the Q1 versus last year. This includes a 17 percentage point benefit related to in transit as we lapped the prior year supply chain challenges and 4 percentage points of decline related to pack and hold inventory. The remaining decline is primarily driven by a decrease in fashion and seasonal basic inventory. As you know, we made significant progress rightsizing inventory as we exited fiscal 2022.

Speaker 4

We remain focused in fiscal 2023 on moderating buys, leaning further into our responsive levers and continuing to integrate the inventory that was placed in pack and hold in fiscal 2022 into future assortments. As a result, we are planning for inventory to be down significantly more than sales as compared to fiscal 2022. Quarter end cash and equivalents were nearly $1,200,000,000 an increase of 38% from the prior year. Net cash from operating activities was $15,000,000 in the quarter, driven primarily by improved inventory levels and leaner buys. Capital expenditures were $117,000,000 Consistent with typical first quarter seasonality, Free cash flow was an outflow in the quarter of approximately $102,000,000 We remain confident that cash flow trends will continue to normalize throughout fiscal 2023.

Speaker 4

As we told you last quarter, we expect to be positioned to pay down the $350,000,000 draw on our asset backed line of credit this year. In fact, last week we paid down $100,000,000 and intend to pay down the remaining $250,000,000 balance throughout the remainder of the year. 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 and on May 9, our Board approved maintaining that $0.15 dividend for the Q2 of fiscal 2023. Now turning to our outlook.

Speaker 4

We continue to take a prudent approach to planning in light of the continued uncertain consumer and macro environment. Starting with Q2, let me first provide an overview of factors impacting year over year sales comparisons in the 2nd quarter. Gap China represented approximately $60,000,000 in sales last year in Q2 and is expected to be approximate 1 to 2 percentage point headwind to Gap Inc. For the quarter. We are assuming an estimated 1 point foreign exchange headwind in the 2nd quarter.

Speaker 4

We are estimating total net sales in the 2nd quarter to be down mid to high single digits year over year, reflecting a range of outcomes based on what continues to be an uncertain macro and consumer environment. We expect gross margin improvement in the Q2 versus last year. Compared to the 36% adjusted gross margin in the Q2 last year, we anticipate an estimated 200 basis points of leverage as we lap last year's elevated air freight and continue to drive lower normalized air expense. An estimated 200 basis points of deleverage due to an inflationary cost headwinds, primarily cotton cost headwinds similar to Q1. We expect these inflationary headwinds to moderate become a tailwind in the back half of the year as we benefit from lower commodity prices as well as improved ocean freight rates.

Speaker 4

This 200 basis point inflationary headwind is expected to be fully offset by improved promotional activity as a result of improved inventory positions relative to last and ROD is expected to delever by approximately 50 basis points compared to last year. We are planning for adjusted SG and A of approximately $1,300,000,000 in the 2nd quarter largely reflecting the continued benefit of last year's savings actions offset by higher incentive compensation. As discussed previously, we expect to begin to benefit in the back half of the year from the $300,000,000 in annualized savings related to actions we are taking to optimize our operating model and structure that we began implementing last month. Now turning to full year 2023, as a reminder on the factors impacting year over year comparisons, GAAP China represented approximately $300,000,000 in net sales last year, representing an approximate 2 point headwind to Gap Inc. In fiscal 2023.

Speaker 4

Fiscal 2023 will have a 53rd week estimated to add approximately $150,000,000 to net sales or approximately one point of growth. As we look to the remainder of fiscal 2023, we continue to believe net sales could be down in the low to mid single digit range for the year. Turning to gross margin, compared to the 35% adjusted gross margin in fiscal 2022, adjusted gross margin in fiscal 2023 is expected to be driven by an estimated 200 basis points of airfreight leverage as we lap last year's elevated airfreight and continue to drive down normalized air expense. Approximately 50 basis points of deleverage versus last year stemming from inflationary cost headwinds. This is an improvement from our prior expectations of a 100 basis point headwind as we are experiencing an improvement in ocean freight rates earlier than previously planned.

Speaker 4

We anticipate approximately 250 basis points of inflationary deleverage in the first half of the year shifting to a tailwind of approximately 150 basis points of leverage in the back half as we benefit from improved commodity costs and ocean freight rates. We continue to expect more than 100 basis points of margin benefit in fiscal 2023 as a result of our better inventory position and expected improved promotional activity compared to last year. And rod as a percentage of sales is planned to be roughly flat to down approximately 50 basis points compared to last year. We continue to target fiscal 2023 adjusted SG and A to be down low to mid single digits from the prior year or approximately $5,200,000,000 As we communicated last quarter, The higher incentive compensation and wage inflation plan for fiscal 2023 is expected to be fully offset by approximately $250,000,000 of cost savings implemented in fiscal 2022. In addition, as discussed earlier, we expect to realize roughly half of the $300,000,000 in annualized savings related to the optimization of our operating structure, including the elimination of approximately 1800 corporate and upper field roles.

Speaker 4

We now expect capital expenditures in the range of $500,000,000 to $525,000,000 down from our prior range of $500,000,000 to $550,000,000 largely reflecting lower capital project investments as well as fewer store openings than previously planned. We now plan to open a net 25 to 30 Old Navy and Athleta stores in total, roughly 1 third Old Navy stores and 2 thirds Athleta stores. We continue to plan to close a net total of 50 to 55 Gap and Banana Republic stores in North America, of which approximately more than half are Gap stores and the remaining Banana Republic stores. We are entering fiscal 2023 better positioned as a result of the We are taking to change the trajectory of our business, not only in the near term, but even more importantly, setting the company up for the long term. We are confident in the actions we're taking and believe we are taking the right steps to position Gap Inc.

Speaker 4

Back on its path towards sustainable profitable growth

Operator

Thank you. As a reminder, for those analysts who wish to participate in the question and answer session after the presentation, You may now press star 1 to enter the question and answer queue. Our first question comes from the line of Alex Stratton from Morgan Stanley. Your line is open.

Speaker 4

Great. Thanks so much for taking my question. I have a couple that are probably best answered by Katrina, So both related to revenue. So on the quarter, is there any color you guys can give us on how it trended? Was it consistent?

Speaker 4

Did it strengthen or weaken As you got to the total result. And then on the 2Q guidance, it looks like you're assuming a worsening at the midpoint from the 1st quarter levels. Does that mean that you've seen a slowing in the business quarter to date? And is there any particular segment driving that? Thanks a lot.

Speaker 4

Hi, Alex. Thanks for the question. So, I think on your first question, I would say we are obviously pleased that we were able to deliver on our expectations in the Q1 for revenue. And what we observed, I think is largely in line with what we heard others report, which is that February Was quite strong and probably benefited from the fact that it was warm everywhere. And then in March, we definitely saw Similar weakening to what I think you've heard articulated, largely as a result of the regional bank situation that was playing out and the impact that that had to consumers as they tightened in March.

Speaker 4

And then a little bit of a recovery in moderation in April, But we were navigating the lower tax returns. So again, delivered the quarter, but what we're observing is a much choppier environment for the way that the consumer is reacting to the news and how that's impacting the way they spend. As it relates to Q2 then, We have seen a little bit of that softness continue into May. But what I would say is that that's considered In the outlook we just provided and the reason why we gave a range for Q2 is that we're trying to provide for Whatever scenarios could potentially play out with some of the choppiness that we're seeing out there and if there are situations where the consumer can track. So, hopefully that's helpful, but that's how we're thinking about it.

Speaker 4

Super helpful. Good luck. Thank you.

Operator

Your next question comes from the line of Matthew Boss from JPMorgan. Your line is open.

Speaker 5

Great. Thanks. So Bob, you cited market share gains at the Old Navy brand. Maybe could you just And on trends that you're seeing in that business and how you feel regarding the balance today in your assortment, maybe relative to what you see driving the softer Athleta performance.

Speaker 2

Yes. Hi, Matthew. Yes, I mean, we're certainly pleased to see the momentum carry in to drive the market share gains. And As you heard us point to a little bit in our last conversations, women's in particular, we're really strong. We cited some examples like pocket dresses and so forth.

Speaker 2

And that really has spilled over into several other categories. But As I think you were sort of referencing, it's really where our mind is as well. We still see the brand over assorted from where we want it to be. And again, that's just part of this transition that we're working through. But we've continued to see good gains in and around Categories that we'll know or we believe that we'll continue to see greater strength in.

Speaker 2

The brand itself is In a period right now again making a lot of those adjustments coming out of cleaning up its inventory, getting rid of the packet hold and So forth and I think the kind of performance that we'll see going forward will add a little bit more clarity around the categories in particular that We believe the brand will really thrive on long term. But right now, I'm happy with the progress and again to see the kind of gains Help us with some momentum. Look, on Athleta, it's just really clear that we walked away a little bit too far from our performance DNA. Definitely had some misses in and around product specifics, silhouettes, color and even just some of the styling, etcetera. And that really again gave us a big challenge relative to that What she's coming in for, although our bottoms continue to be really strong, we have to be able to capitalize on a lot more than that.

Speaker 2

And everything that that brand stands for, for that customer, we're not backing down from at all. The power of she, the emotion in the brand, performance, Why we are moving aggressively to get in more aggressively in like running, yoga, some of those areas that we know have been real big misses for us. It's what that team right now is really focused on. And as we commented in our remarks, I'm really pleased right now how the current team is Making the most, if you will, out of everything we have that the customer is really resonating with. And we look forward to seeing that brand Find and Stride again, no pun intended.

Speaker 2

But we know you know how important that brand is to the company, and we're optimistic that we're going to get back where we need to be.

Operator

Your next question comes from the line of Brook Roche from Goldman Sachs. Your line is open.

Speaker 6

Good afternoon. Thank you for taking our question. Can you talk to the composition of your today and your current ability to chase into products that are resonating with the consumer. How much chase ability do you have? And do you think that could potentially improve your performance into the back half of the year?

Speaker 6

And then similarly, Katrina, can you provide some updated comments on your outlook for free cash flow. Thank you.

Speaker 2

Go ahead and take the chase part and I'll add to it. Sure.

Speaker 4

I I mean, I think, Brooke, we're really pleased with the fact that we were able to get our inventories down to where they are not only on a 1 year basis, But really back to 2019 being much more in line with what we consider to be healthy inventory levels. And I think you saw that show up in the gross margin performance For the quarter where we were able to still offer a lot of value to the consumer, but we didn't have all the markdown cleanup from last year that we had to deal with and so we were able to really clean up the overall margin. So we feel good about that piece. As it relates to Chase, I think We've talked about this. We are now back to being able to reinstate our responsive capabilities and a lot of the organizational structural changes that we made in the business will also help us really have better line of sight to end to end inventory management and allows us to get back to really chasing into trends that are working.

Speaker 4

I think what's different is that Old Navy is back to pre pandemic levels of chase, if not slightly better. But now we have the capabilities across our brands, which is Really nice to see and so all of our brands should be able to be chasing inventory much closer to the consumer. I don't know if you wanted to add anything Bobby?

Speaker 2

No, I think you covered Well, I think, Brook, the one thing that I would just highlight again from my seat is, look, I mean, supply chain capabilities is something that we've really long That is a core strength and I would say that a few things got away from us a bit. We're back really capitalizing now on our vendors who work with us very strong collaboratively, helping us with consumer insights, engaging, if you will, with innovation and All of that that moves through the pipeline. So to your question about our expectations around the back half, I would say the We believe that we're finding ourselves back where we've got great leverage points. We're seeing good success as we chase back into product And again, really getting back to that discipline and rigor in a very effective way. So I'm actually proud of that progress really, quite proud.

Speaker 4

And then Brooke, as you asked, obviously, our discipline around inventory and expenses combined with better operating performance is Giving us more confidence in our free cash flow outlook. I think you heard on the call, the free cash flow cash flow in the company through better operating performance. So more to come as we see where the year comes out. Yes.

Speaker 6

Thank you very much. I'll pass it on.

Operator

Your next question comes from the line of Lorraine Hutchinson from Bank of America Global Research. Your line is open.

Speaker 4

Thank you. Good afternoon. I'm curious to hear more about the reduction in promotions at Old Navy. Can you about where margins are versus pre COVID levels for that brand and also what the reaction has been to some of your recent price increases? Thank you.

Speaker 4

Yes, Loreen, thanks for your question. Interestingly, when we look at the composition of the margin benefit that we got in the quarter Across all of our banners. Again, the reduction in inventory has really allowed us to clean up the markdown piece of the business, which doesn't add a lot of customer value, right? That's just inventory that last year wasn't responded too well by the consumer and we had to sell Through, given excess inventory, the wrong inventory. So the margin benefits coming from cleaning up that markdown, what that's allowing us to do is still promote, Which is a better way to be offering value to the consumer, which is still important at this time.

Speaker 4

And that's true at Old Navy. As it relates to price increases, I would say overall, we are not seeing a lot of adverse reaction to price increases. The team was very surgical around taking up prices on categories or items that are known to be important in the consumer's wardrobe right now like wovens or pants or our outstanding fashion items that just You know, are so well that the customer has to have it. So I would say as we look back, we feel very good about where the teams have priced up. And the promotions have remained rather competitive as far as versus pre pandemic, we're still better off than pre pandemic.

Operator

Thank you. Your next question comes from the line of Jonah Kim from Cowen and Company. Your line is open.

Speaker 5

Hi, this is Neil Goh filling in for Jonah today. Thanks for taking my question. Just kind of touching on this From your point earlier, can you just give some more color on, how that promotional environment has been perhaps different income cohorts and demographics since that was One of the brighter spots and then what are you assuming from a timing perspective for the rest of the year as we eventually enter the back to school period?

Speaker 3

Thanks.

Speaker 4

Yes, Neil. So I think what's interesting on our income cohorts is that it continues to be similar to what we've seen in the back half into Q1, which is when you look at markets where we have a demographic of a low income consumer, we are certainly seeing those Consumers contract their spending and being much more price sensitive. In areas where we have the higher income consumer, There's a lot less price sensitivity and they are still spending. So that dynamic has continued. And as of now, We'll see how that plays forward.

Speaker 4

But that's part of the reason why we have ranges of outcomes around our revenue performance is because We don't know what will happen as we head into the back half of the year and decide whether we will need to compete more or less. I think so far what we've seen and maybe you've heard this more in the industry is that as we just talked about, we've had to do less promotion to clear inventory because our inventories are so much more in line and really our promotions have been more focused on adding value to the consumer, which we hope will be more revenue driving actions and less about clearing inventory.

Speaker 7

Great. Thank you.

Operator

Your next question comes from the line of Cory Carlo from Jefferies. Your line is open.

Speaker 3

Hi, good afternoon. First, wondering, Katrina, if you could just assess for us the health of the Gap Store Fleet. I think over the last 2 years, you've closed something like 370 stores. The segment actually comped positively this past quarter. So it would be helpful to just get some color there.

Speaker 3

And then just on the Old Navy improvement that you're witnessing, Recognizing that there's still more work to do, maybe could you talk a little bit about what that work is and how far along or maybe what inning you think we're in, in terms of the Old Navy improvement.

Speaker 4

Yes, Corey, as you say, historically we've worked aggressively on over the last 3 years during the COVID pandemic. And so as you say, overall, we have closed Or will have closed by the end of this year about 350 Gap and Banana stores. So both of our specialty fleets we've been working on. And Do I think we're done? I don't know, but we are largely through the lion's share of the restructuring activity that had to be done.

Speaker 4

And I think as you say, that is showing up in the fact That the balance of the fleet that's remaining is relatively healthy. Now we need to continue to work on keeping that fleet healthy. But fundamentally right now, I think we feel pretty good with where we've positioned both our Gap and Banana Republic fleet. As it relates to Old Navy, I think you've heard us call out that We feel really good about the fact that we gained share in women's. I think we would say that we would like to Seeing more momentum in men's and kids.

Speaker 4

And then within some of the categories, I think active as an example where We've gained a lot of share over a multiyear period, but we're seeing a little bit of reversion there and there's probably some more work to do to get that assortment back to being current. But I don't know, Bobby, if you want to comment more on that or maybe

Speaker 2

No, I mean, again, I think we're kind of indicating again, we're seeing it travel along the journey here, again, getting the assortment Really rationalize and balance the right way. Look, you guys realize this as well as we do. This is across all brands. We design into the coolness of the brand relevance, the creative being right on fashion and Getting inventory under control always when we do that, we're always going to do a better job in driving brand relevance, maximizing marketing Effectiveness that certainly is true around the right promotional approach and balance for Old Navy. And in turn, I think continue to allow it Produce the kind of margin that we want to see and structure to run with and compete with and get back again to really the essence of that brand.

Speaker 2

That brand has always been known for fund, if you will. And the brand itself is or the team is working around what future of fund looks like around that brand and how it differentiates itself in the marketplace. Staying close to the customer, you guys touched on it and I'll just acknowledge it back. That's a value proposition that we know we compete in very aggressively. I like the work that the team is doing, the rigor they're putting in around The right diagnostics at every level, from whether it's online or in store.

Speaker 2

This merchandising structure change where we're moving ahead of commerce. So we're bringing together both the online and the in store together Around the experience and everything we're doing from a product and service is all a part of these improvements that Again, we're counting on and Old Navy in particular probably one of the bigger beneficiaries as we land all that work.

Speaker 3

Great. Thank you very much and best of luck.

Operator

Your next question comes from the line of Mark Altschwager from Baird. Your line is open.

Speaker 7

Good afternoon. Thank you for taking my question. I wanted to follow-up on the promo topic as well and gross margin. It seems like the promo recapture was really the key driver to the upside expectations in Q1 at least relative to our model and I think how many were looking at Q1 gross margin. Is that magnitude of recapture a good run rate to think about as we move through the next few quarters?

Speaker 7

And Just given your comment about promo shifting more to being used to engage the customers versus clearing inventory, If we were to see some moderation in that Q1 result, I mean, would it be fair to think that we could maybe see some incremental top line benefit as we move through the year? Thank you.

Speaker 4

Yes, Mark, it's such a good question and one I'm really glad you asked. So the upside in Q1, as you say, we saw modest upside from freight, which we talked about, but really the bigger upside, I think came from less discounting. I would not use the 380 basis points of benefit from discounting as a run rate. We just Said that in Q2, about 200 at least 200 basis points of the inflationary pressure will get offset in discounts, so that already nods to a moderation. And then for the full year, we said at least 100 basis points in that discount.

Speaker 4

And you could ask why wouldn't we see more? I think right now what we're saying is that's the way we'd say maybe a floor of what we think that's worth. We'll see how hard we have to play in Q2 and beyond depending on where the consumer goes and whether that shows up in revenue or whether that shows up just in us having to play harder to be able to compete as we move through the year. So I'm glad you asked the question. Those do moderate as we get through the year.

Speaker 4

And again, depending on where the customer lands, we'll see whether there's upside there or not.

Speaker 7

Very helpful. Thank you.

Operator

Your next question comes from the line of Paul Kearney from Barclays. Your line is open.

Speaker 7

Hi, everybody. Thanks for taking my question. Can you talk more about some of the efforts to reduce cost And simplify, how will the changes you've made improve responsiveness throughout the organization? And are there additional levers to drive sustainable savings as you rebase this year? Thanks.

Speaker 2

Hey, Paul. It's Bobby. I'll start and see if Katrina wants to add on to it. But look, I think it almost goes without saying. Getting rid of layers from 12 to 8, the effect on span of control, it's really clear that where we found ourselves was Really slowing down and impacting our ability to be quick on decision making as well as Certainly identifying where we've had productivity misses and the like.

Speaker 2

So that work I don't think should be understated. It's difficult work that's gone on. But we found ourselves with an SG and A, obviously, that was untenable, not one that we would book to continue to try and compete with. So pulling out the cost is relevant and it's meaningful. But again, I'll just go back and point to the big Payback and unlock here is again as I've made in my I mentioned in my comments, the big payback We're going to start showing up more informed, more in tune with the customer being driven by consumer insights, more responsive and the like.

Speaker 2

So We're not doing anything here other than I hope what you caught is we're in pursuit of a mindset change and A cultural shift that keeps us in this mode all the time of continuous improvement and looking at how we continue to not just cut the cost, but Again, get ourselves where we're far more responsible are responsive, agile and again, a lot more competitive. Just one more time, I'd say difficult work in the short time that I have been here, although they feel all that short. I'm really pleased with, again, the way the team has Embrace this change. Any of us that have watched this level of change happen, we know it takes a lot. And right now, I think our quarter results Indicate some good or show some good indication of where we have reason to be pleased with part of it, but we have a lot farther to go and a lot more work to do.

Speaker 4

And Paul, I think to add on what I would say is regarding further savings. Right now, we're really pleased with the cost savings that are coming from these organizational changes as well as some early savings we got last year in marketing through some contract negotiations and a little bit of tech. But marketing and technology, I think, are the two areas that we've identified we have Further opportunity in and now that we have our organizational structures in place and those teams get settled, we'll begin the work to really understand what the next opportunity will look like. Some more to come when we get through the organizational change and are able to sort of move our focus to those next items of opportunity.

Speaker 7

Very helpful answers. Thank you.

Operator

Your next question comes from the line of Janet Kloppenburg from JJK Research. Your line is open.

Speaker 8

Hi, everybody. Congratulations on the improvement. Nice to see. Katrina, on the promotion and less recapture that assumption for the Q2. Is that a trend that you're seeing right now?

Speaker 8

And do you feel even with your inventories down as much As they are that you've had to step up promotions. And I also wondered, in your guidance for the Q2 and for the year, What the assumption is on kids and men's? Do you expect those categories to improve? Or do you expect that pressure to be maintained as we move through the year? And lastly, I wondered if there was any news on denim and how that might be affecting your back to school outlook.

Speaker 8

Thank you. And one last question, sorry, is just on

Speaker 4

So On the gross margin and promotional trend, I mean, I'm not really going to comment very early in the quarter. So we'll see. We've given you a sense For the year, I mean for the quarter the year where we think those things will land. And so we'll see how it goes. Memorial Day is coming up.

Speaker 4

That's usually a big kickoff to And so we'll see how that all goes. On the kids and men's thing, kids in general, the market Place has been down. So while our kids business has been modestly under pressure, we've been gaining share at Old Navy. And We'll see how that goes, but there's sort of a range of possible outcomes for both kids and men's as we look to the Q2 and the second half, All of which are contemplated in the guidance we gave. And then on the denim front, we've been gaining share in denim all year And we gained share again in Q1.

Speaker 4

So we're relatively pleased with what the teams have been doing around denim. And I guess, we'll see how that plays out in back to school, but at least we've got some good momentum heading into back to school in that category. There was a 4th one, I can't remember. Inventory, Katrina. Oh, inventories.

Speaker 4

Yes, so we said in my We do expect for inventories to be down meaningfully more than the sales guide. So we'll see, but we did end up down 27 And that will be our goal is to keep those inventories well under control.

Speaker 8

Thank you and good luck.

Speaker 4

Thank you.

Operator

Your last question will come from Marni Shapiro from The Retail Tracker. Your line is open.

Speaker 9

Hey, guys. Congratulations on some really nice improvements in the stores. I just wanted to focus a little bit on Athleta again because I know this is Growth vehicle for you and important, and as you're searching for leadership there, could you give us an estimated timeline of When you think the changes with color, print and the better balance start to really show up, will it be there for back to school in the fall season I mean for winter gifting. And then if we could also just think forward, do you need new leadership in place to start innovating? Because Even this is a part of the market that is heavy on innovation, the performance part of the market.

Speaker 9

And while I'd like a lot of the styles you have. Some of them have become a little stale while other brands are advancing, in this moment. So I'm just curious if you could talk about those two parts of the business.

Speaker 2

Can we start? First of all, thanks for being so kind, Marni. I would say that To answer your question kind of from the bottom back, do we have new leadership to really start seeing the innovation? I would not take anything away from current team. Again, our focus has really, I think, enabled a lot of moves and changes there.

Speaker 2

We've already seen Wonderful contributions from Julia Leach, who we added is kind of fresh perspective on the creative side. You do understand obviously quite well because of the question that fabrications and other things really are a little bit longer pipe for this brand. That said, The brand is taking every opportunity we can where if it was an opportunity for raw material to be adjusted a bit to land something for Fall, perhaps holiday. There are opportunities being engineered into that. But to go much farther than that, I think that would be too aggressive.

Speaker 2

At the same time, this team is amazing me right now, everything that they're doing to come up to maximize opportunity. What's most important obviously here is, again, we know what this brand stands for. We know what she looks for every time she comes in. You just highlighted it again. And it will take us a while to get back Where we need to be, but hopefully we will exceed your expectations and mine.

Speaker 9

I hope so. I just ask one follow-up. You've been promotional obviously to clear out the inventory and it's going to take some time to fix this. Even within the store today. Are there things that she's buying that don't need a promotion?

Speaker 9

And is there a risk that she gets used to 20% off, 30% off, 40% off there. So how careful do you have to be over the next couple of months in dealing with this?

Speaker 2

Go ahead, Pritchard.

Speaker 4

Yes, Marni. I mean, I think that's a great question. We certainly see that there are core performance bottoms and there are fashion styles that don't need a promotion and the team is being very cognizant on trying not to Train her for promotion by utilizing markdowns better to be more targeted. But there is a reality of Where we are today and where we need to go. The ultimate goal will be to get that brand back to not relying on promotions to be able to drive the business, but drive the business Through its fashion authority and its innovation and its positioning, and that is what the team is working towards long term.

Speaker 4

So it's a great question And one that the team is definitely focused on.

Speaker 9

Tell the team I'll welcome back the new product. Enjoy. Best of luck for the next quarter.

Operator

Thanks, Marty. Thank you. That does conclude our conference call. You may now disconnect.

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