The Gap, Inc. (GAP) Q2 2020 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen. My name is Christy and I will be your conference operator today. At this time, I would like to welcome everyone to the Gap, Inc. Second Quarter 2020 Earnings Call. [Operator Instructions] Today’s call is being recorded. And at this time, I would now like to introduce your host, Tina Romani, Head of Investor Relations.

Good afternoon, everyone. Welcome to the Gap, Inc.’s second quarter 2020 earnings conference call. Before we begin, I would like to remind you that the information made available on this webcast and conference call contains forward-looking statements. For information on factors that could cause our actual results to differ materially from the forward-looking statements as well as the description and reconciliation of the non-GAAP financial measures, as noted on Page 2 of the slide supplementing our remarks. Please refer to today’s earnings press release as well as our most recent quarterly report on Form 10-Q filed on June 9, 2020 and our subsequent filings with the SEC, all of which are available on gapinc.com. These forward-looking statements are based on information as of August 27, 2020 and we assume no obligation to publicly update or revise our forward-looking statements. Joining me on the call today are Chief Executive Officer, Sonia Syngal and Chief Financial Officer, Katrina O’Connell. As mentioned, we will be using slides to supplement our remarks, which you can view by going to the Investors Section of gapinc.com. With that, I would like to turn it over to Katrina. Katrina O’Connell: Thank you, Tina and thank you everyone for joining us today. The COVID pandemic has been challenging for everyone, including impacting The Gap Inc. business as I will discuss in a moment. But more importantly, I want to acknowledge the tremendous effect this has had on everyone’s lives from a health, economic and social standpoint. At Gap Inc., we believe strongly in leading with our values, especially in this time of need for so many people. We hope you and your families are well and healthy, particularly as we recognize the continuing challenges we all face. For today’s call, I am going to start with a review of the company’s second quarter performance, followed by our thoughts on the remainder of fiscal year 2020. Following that, Sonia will share her perspective and then we will open it up for Q&A. Before I jump into our second quarter results, I want to share thoughts on the transition from the first quarter to the second quarter. We have been highly focused on executing steps to ensure liquidity for the company, including addressing the challenges of widespread store closures. We also recognized we have an opportunity to drive growth focused – through focused investments and by leveraging our best-in-class capabilities to return the company to improved sales performance and margin improvement. I am pleased to say we delivered on this in second quarter. So, I would like to touch on a few highlights. First, driven by the performance of our 3, soon-to-be 4 iconic billion dollar plus brands, in combination with the many steps taken across the organization in support of cash preservation and liquidity, we have the best second quarter operating cash flow in at least 5 years. This has put the company in an excellent financial position. Second, our teams remain focused on driving the fundamentals of the business, while also taking aggressive steps to support the company’s financial stability in the midst of COVID-19. Our online sales grew 95% compared to Q2 2019 supporting our customers’ choice to shop our brands in the channel platform or format where they are most comfortable. And we have reopened about 90% of our stores providing safe places for our consumers to shop in person or curbside for the products they love. We also significantly improved our inventory position following a turbulent first quarter marked by store closures and we now have inventory levels that more closely align with customer demand. And lastly, while discussions with landlords continue, I am pleased with the progress we have made towards our goal of a more profitable store fleet. We will provide an update today, but we also look forward to sharing a broader longer term update with you during our Virtual Investor Meeting on October 22. Now, let me turn to our results in the second quarter. Total company net sales were down 18% representing a significant improvement versus the preceding quarter. Online sales increased 95%, which modestly benefited from shipment timing offset by 48% decline in store sales, reflecting store closures that began in Q1, followed by meaningfully improved results as stores reopened over the course of the quarter. It’s worth noting the company delivered a positive 13% comp in the quarter supported by our scaled online business, which represented roughly half of our sales this quarter. In particular, Old Navy and Athleta continue to outperform as customers respond positively to their strong product offerings and relevant marketing messages. Second quarter gross margin was 35.1%, down 380 basis points compared to last year. This reflects 270 basis points of de-leverage in merchandise margin as well as a 110 basis point de-leverage in rent and occupancy driven by a decrease in net sales largely due to store closures as a result of COVID-19. Merchandise margins reflect an unfavorable impact of higher shipping costs in support of online sales, partially offset by product margin expansion due to lower discounting in response to strong demand for our products across nearly all of our brands. And we noted last quarter we serviced a meaningful portion of our online orders through stores, which is a more expensive fulfillment option to support customer demand. As we look ahead, we have now better aligned our inventory to the elevated demand in our online channel. With that shift of inventory by channel, we expect shipping expense while still higher than last year with continued growth in the channel to moderate somewhat in the second half of the year. Before I touch on the SG&A expense in the record second quarter results, let me update you on our focus to improve the profitability of our store fleet. As you know, we are committed to the rationalization of our Gap and Banana Republic store fleets as we look to improve the profitability of those brands. While landlord negotiations are ongoing, we currently expect to close over 225 Gap and Banana Republic stores globally on a net basis in 2020, ahead of our previous expectations with line of sight to additional store closures in 2021. During our Virtual Investor Meeting in October, we will be able to provide you with a further update, but all said, I feel very good about our progress here. Second, while we paused rent payments on store locations that were required to be closed due to the COVID pandemic something we shared with you last quarter, we continue to reflect full rent expenses on all stores in our financial statements as required by accounting practice. We continue to negotiate with our landlords to improve economics for all parties. To-date, we have negotiated agreements on a number of our leases and more agreements are anticipated over the next several months. Turning to SG&A, SG&A in the quarter declined by roughly $200 million driven primarily by reduced store payroll and other store expenses related to closures. This included investing in in-store safety measures, something we led the industry at as we welcomed our customers back to our stores. As a percentage of sales, SG&A was 32.9% or 110 basis points higher than the year ago quarter as expense reduction was more than offset by lost sales from COVID-related store closures. So from an EBIT standpoint, with our improved sales performance versus the first quarter and tight expense control, the company delivered second quarter operating income of $73 million or 2% of sales. As discussed during our first quarter earnings call, the company redeemed the $1.25 billion in unsecured notes due to mature in 2021 as part of the refinancing, reflecting the issuance of $2.25 billion of senior secured notes. In retiring the 2021 notes, the company incurred a $58 million make-whole premium. This charge is non-recurring and classified as a loss on extinguishment of debt on the income statement. Aside from the non-recurring charge, second quarter net interest expense was $56 million, reflecting increased interest expense as a result of our new financing. We expect net interest of approximately $55 million per quarter on a go forward basis. The effective tax rate for the quarter was negative 51%, which reflects changes in the estimated benefits associated with the enactment of the CARES Act due to the company’s strong performance in the second quarter and the impact from the geographical mix of pre-tax earnings. Our year-to-date effective tax rate was 23.5%, which represents a more normalized rate given the impact of earnings variability and the CARES Act benefit on the second quarter. Earnings per share, was a loss of $0.17, a significant improvement from the first quarter. Turning to the balance sheet, on a reported basis, we ended the quarter with inventory down about 4%. Recall as part of a disciplined approach to managing inventory in the face of uncertain demand, we implemented a pack and hold inventory approach, whereby select summer product is being held and will be released during next year’s selling season. As a result, pack and hold inventory will remain in our reported inventory numbers until the same time next year. End-of-quarter inventory, excluding pack and hold, was down about 10%. Looking ahead, we continue to expect inventory, excluding pack and hold to be down mid single-digits for the remainder of the year. Let me turn to cash flow. As we discussed last quarter, fundamentally, Gap Inc. is a strong cash flow generator with over 10 plus consecutive years of at least $1 billion of operating cash flow. Our second quarter operating cash flow is a testament to the cash generating power of our business. While we took important steps to preserve liquidity as outlined last quarter, the strong cash generation we saw in the second quarter was largely a result of improved sales performance. Overall, with new financing plus strong operating results, we ended the quarter with a cash balance of $2.2 billion. Year-to-date capital expenditures were $208 million. And for the full year, we continue to expect capital expenditures of approximately $300 million with the majority of spend oriented towards technology and supply chain investments that support changing customer shopping habits and are aligned with our strategic intent to create a seamless journey for our customer across any touch points that she engages with, whether in our stores, on our sites, using our app or through social media. And lastly, before I turn it over to Sonia, let me give you some thoughts on the remainder of the year. Given the high level of uncertainty in the current environment, we are not providing a fiscal year net sales or earnings outlook at this time. However, to be helpful, let me provide some thoughts on the back half. First, we expect net sales to continue to improve versus the second quarter, reflecting meaningful online sales growth, coupled with continued recovery following the reopening of our stores. We expect our sales performance to be fueled by continued strength at Old Navy and Athleta partially offset by revenue loss from strategic closures of unprofitable stores as well as the potential for continued weakness of Banana Republic. Second, as it relates to expenses, it’s important to note that we will continue to face higher operating cost as we serve our customers during the pandemic. In particular, we are now applying our best-in-class store safety measures to our largely reopened fleet, resulting in meaningfully higher store expenses in the first half. In addition, we continue to expect higher shipping expenses as online growth is expected to outpace last year. And lastly, we are strategically investing in marketing behind our brands as we focus on gaining share in this disruptive environment and at a time when trusted brands matter. As we look to the back half and beyond, we remain committed to amplifying our distinct advantages and scale to capture demand and gain share, including leveraging our scaled and advantaged omni capabilities across our stores and e-commerce, harnessing the power of our brand and enviable customer file to drive loyalty, engagement and frequency, leading to our values at a time when trust matters, and continuing execution of our initiatives to drive profitable growth through streamlining our operating model and fleet optimization. We look forward to discussing more with you at our investor meeting in October. And with that, I will turn the call over to Sonia.

Thank you, Katrina. Couldn’t ask for a better partner and good afternoon everyone. I am glad to speak with all of you today in a very different position than last quarter. We began Q2 with all North America stores closed to customers and we ended the quarter growing sales and improving profitability. As we pivot to offense, I am encouraged by three things. First, fundamentally, our business is healthy and I am proud of what the teams delivered in Q2. I will share more on this shortly. Second, despite uncertainty ahead, I am confident that our unique strengths, our powerful brands, our size and scale, our relevant product and our omni capabilities are helping us win now and will position us well for the back half and will support this company in any environment going forward. This is important as it will allow us to take share as the apparel market reshapes itself. And third, the long-term potential for Gap Inc. and our brands is significant. We have been highly focused on crystallizing our strategy and plans for value creation, which we will look forward to sharing with you in October. Let me touch on each of these. We feel great about our performance in Q2 and our customers’ loyalty to our powerful purpose driven brands. I am really proud of our teams for rising to the challenge by relentlessly driving for growth, making opportunistic moves in crisis, intently managing cash flow to build financial resilience. This showed up in our top line with online sales nearly doubling versus last year driven in part by year-over-year growth in our active and fleet businesses, which in Q2 make up about 24% of total sales. We won in the value space with Old Navy and we won in the premium space with Athleta in this very important category. At the same time, we strategically walked away from unprofitable sales by choosing not to reopen select Gap and Banana Republic stores as part of our ongoing fleet restructure. I am impressed with how quickly the teams moved across every aspect of our business. We launched new digital capabilities and shipping scale safely reopened nearly the entire fleet of North America stores and we pivoted to relevant marketing led by our values and chasing into products our customers want now. So, we entered the back half in great shape and understanding it will be unpredictable, still with opportunities to grow sales, improve margins and invest in the business. With the back half comes back-to-school, which was different for many families this school year. What hasn’t changed is the family ritual of shopping for supplies and cool clothes to allow kids to feel their best whether they are learning at home or socially distanced in a classroom. Since our brands distort the casual active and relevant, we have the assortment that is needed in any learning scenario. We expect back-to-school season to extend over a longer period and we are ready to deliver for our customers online or safely in stores whenever they are ready to shop. In a rapidly changing environment, we are playing to our strengths, focusing on the key advantages where we can differentiate and compete to win now and in the future. I would like to talk for a minute now about our purpose-driven lifestyle brand, the backbone of how we meet customer’s needs and ultimately create value for investors. And the connection that our customers have to our brands is strong and something we plan to amplify. First, Old Navy, representing more than 50% of sales, Old Navy is democratizing style, offering customers trend right fashion in the value space and growing market share in core categories like active and fleece, lounge and kids and baby. As customers return to stores, traffic in the brand’s off-mall strict real estate locations, which make up approximately 75% of the fleet, ramps more quickly than other formats and continues to be an advantage. They dominated in online and customers responded strongly to the marketing strategy to pivot to focus on brand values through We Are We TV spot and greater investment in digital channels to drive traffic. Next, Gap. Gap maintains strong emotional connection to its customers with its legacy of bridging gaps between individuals, generations and cultures. As our second largest brand, there is demand for this brand and we are committed to growing relevance and further reach through partnership, licensing and a greater focus on online. Gap brand is maximizing online demand through fresh, energetic marketing and a decrease in discounting and the customer is responding. Athleta, our fastest growing brand is clearly established as a lifestyle brand in a growing athleisure market and is extending its reach to women and girls through female empowerment, new experiences and storytelling that meet customers where they are. Through a focus on digital marketing investments, the team unlocks significant momentum in new customer acquisitions during the quarter. And Banana Republic has had the potential to take share in a rapidly evolving marketplace by delivering acceptable luxury. While disadvantage in the short-term due to the shift towards casual fashion as people are working from home, the team is adjusting assortments quickly and pivoting storytelling with elevated product photography to drive online improvements. Longer term, we believe Banana Republic has a place to redefine workwear or work leisure in a post-COVID work environment. Together, our brands are well-positioned across age, gender, occasion and life stage and each brand must deliver products and services that contribute meaningfully to our customers’ lives through distinct customer relationship. This is the cornerstone of how we will expand and monetize our brands. Another way we differentiate is through direct customer relationship. We have 50 million known active customers and a total customer file of 170 million, which we use to connect with our customers everyday to increase our ability to tailor experiences, content and product through a personalized journey. We are excited to extend our loyalty program in September, a capability that will enhance and build over time and one, that is key to deepening our customer relationship and in buying more loyalists to fall in love with our brand. We are also expanding our reach to address market share opportunities. Like Old Navy’s recent tween launch with POPSUGAR and the extension of Gap Teen with a new collection for boys in Q2. And we are excited about Gap Brands’ upcoming easy assortment, which is another example of leveraging our brand power to reach new customer segment. Next, our expansive online business and omni capabilities, our unique scale across all digital platforms and in our stores gives us advantage to deliver seamless experiences to our customers, no matter where they choose to engage and shop. And we will bolster this with the addition of two payment options, PayPal and AfterPay, which we will launch this fall. We are positioning our brands to be digitally led and we are seeing that play out in our results even as stores reopened. In fact, during the quarter, we are proud to say that we added 3.5 million new online customers. And in the midst of strong online growth, our stores matter, serving as an extension of our e-commerce experience and key to building customer relationship and community. At the end of Q2, we have activated curbside pickup and buy online, pickup in store across 1,500 plus Old Navy, Athleta, Banana Republic stores and as of this week, Gap brand as now live with this capability. We know the value of our multi-channel customers. Of our 1.8 million multi-channel customers in Q2, 30% of them had only shopped with us in one channel prior to this. We can grow in each of these channels by differentiating our experience at the intersection of both as we are focused on growing our customer and online talent in order to do this. Crucial to our success is relevant product. With an average customer review of 4.5 out of 5 stars, our style, quality and fit are resonating with customers, which allow us to have greater pricing authority, resulting in less discounting. The casualization of American style, particularly in light of COVID-19 has played to our strengths, fueling our active and fleece and kids and baby business, which represent nearly $3 billion and nearly $4 billion last year respectively. Going forward, we see room to grow share in these categories even after the pandemic. And we can’t talk about product without talking about masks and our commitment to encouraging health and safety. We sold about $130 million in masks in Q2 throughout – through compelling consumer marketing and digital storytelling that has us ranked as the number one Google search results for facemask style guide as well as an aggressive B2B business launch. The work the team has done to straighten up this business, creating brand right designs that our customers love, continually improving them and scaling the business is the ultimate example of how we want to operate at the culture, chasing big audacious idea with speed and clarity, all with the customer at the heart of our decision. Which brings me to our lean operations, our advantage across supply chain, sourcing, fulfillment, real estate and technology enable us to unlock economies of scale unlike others. It is this scale that allows us to reopen nearly our entire fleet of North American stores with a safe retailing playbook, which is helping to find the gold standard in our industry. We can get leaner. And as Katrina mentioned, we are making progress in optimizing our cost structure, particularly as it relates to our store fleet. And lastly, leading with our values. The past few months have highlighted the importance of companies with authentic values as consumers have become more in tune with how their personal values align with brands that they love. We have always tried to be a company where everyone is welcome, leading on issues like gender representation and pay quality and our brands are positioned to standout in front on these issues. We are fostering a culture where every employee has a strong appetite to win and to learn. And I see the team raising the bar here. I couldn’t be happier with what I am seeing. It is this that will allow us to build a larger platform, a larger business from which we can proudly share our values. So, as we look to refashion Gap Inc. for the future, leveraging the power of our brands and leaning on these key differentiators, that’s what’s going to fuel our success. Now since taking the seat in March, the management team and I have been crystallizing our long-term strategic view of the company. And we look forward to sharing our plans for value creation for Gap, Inc, going forward in our Virtual Investor Meeting on October 22. So with that, I think we will open it up for Q&A.

Thank you. [Operator Instructions] And the first question comes from the line of Lorraine Hutchinson from Bank of America. Your line is open.

Thanks. Good afternoon. I wanted to follow-up on your comments on fulfillment costs and just see if you could parse out a little more detail on how you are thinking about this in the back half, where you think these fulfillment costs will go and then anything you have heard from some of your key carriers around peak holiday surcharges? Thank you. Katrina O’Connell: Hi, Lorraine, it’s Katrina. So, thanks for asking that question. We had a very unique dynamic in our second quarter around fulfillment costs, which was we – as you saw, we got a 95% growth in our online sales. And certainly, we had planned the inventory in our online distribution center to fuel that level of growth. And so the increase in fulfillment costs that we saw in the second quarter was a combination of both the increase of the penetration of online for the business, but also the fact that we were shipping a lot of the demand to fuel that 95% growth from our stores and when we send the inventory from stores, which is actually a good thing given the fact that our stores are ramping up and we were looking to ensure we were clearing that inventory and also servicing demand, it does result in some inefficiencies, like split shipments and more expensive processing. So that weighed on the margin that we got in our second quarter. As we think about the back half of the year, certainly, we expect that we will continue to have higher shipping, because we expect our online business and continue to grow year-over-year, but because we have been able to now learn from second quarter and better invest our inventories back into our online DCs, we expect that a lot of the inefficiencies from shipping from store will go away and that it will be – that part of it will be more normalized.

Yes. Let me just add a little bit about the carriers. And what I will say is our teams have built multiyear longstanding deep partnership with the top carriers and as we stand with among the biggest of their customers, we understand that dynamic is shifting certainly in the industry, but we believe we have a position of strength due to our scale, our differentiated scale and a multiyear relationship where we help our carriers also develop new capabilities that they maybe interested in doing and vice-versa. So, we believe it’s a synergistic partnership that will play well for us and the scale is an advantage for us.

Thank you.

And our next question comes from Paul Lejuez from Citi. Your line is open.

Hey, guys. Paul Lejuez. I am curious if you could talk about the progression of the Old Navy results during the quarter and you mentioned off-mall locations and performing strongly. It will maybe – curious if you saw the same sort of dynamic in the other concepts and also just curious on the stores that you didn’t reopen, what was the cash cost to get out of those leases? Thanks. Katrina O’Connell: Hi, Paul. So, as it relates to Old Navy, as we think about the performance in the second quarter, the dynamic is very similar to the dynamic we have described on our first quarter call, which is Old Navy really performs the best in seeing the traffic rebound given the nature of the fleet. And then as you can imagine, Banana Republic really performed the worst and that’s a combination of their locations, but mostly the fact that we are working through a pivot in their assortment to be more relevant in this COVID world, where work needs to be redefined as Sonia talked about. So I can say that continues to be the dynamic and Gap and Athleta sort of in the middle. And then as it relates to the store closures, we haven’t yet discussed an amount, we are still deep in negotiations on those. And so that will be – we were trying to be helpful by providing the number of stores we now have line of sight to closing both this year and next. And then we will give you an update on the full financial impact of that as well as the savings associated with that once we get to our October event.

Yes. Let me just add a little bit about Old Navy, with net sales down 5% considering stores, the majority of the fleet was closed for in the range of 4 to 6 weeks. It’s really impressive results and it shows the strength of the brands and the momentum that builds as the quarter progressed. So, I will just add that – that the dominance of the online business as reported growing 136% coupled with the pent-up demand that our stores saw, customers really wanted to engage and they are ready to shop with us based on mall locations, based on strength of brand and product. So, I think that we won on both fronts and we are pleased with that. It is certainly the net promoter scores that we saw in our stores as we reopened was a major advantage for us in our stores and in Old Navy, we saw double-digit compared to last year customer experience. And so that was I think some of our customers really valued the safe shopping environment, they valued the engagement, the experience that they had and I think shopping continues to be very, very important ritual.

Thank you. Good luck.

And next, we will go to Kimberly Greenberger from Morgan Stanley. Your line is open.

Great. Thank you so much. Good afternoon. I understand that you, under normal circumstances, don’t provide sort of a current tone of business. And for understandable reasons, we are all just sort of operating in an environment that’s so uncertain. So I am wondering if there is perhaps either some month to month commentary in the second quarter or maybe in August, any color on August or just what you are seeing here in the third quarter that could help us at least try to put together the puzzle pieces of thinking about what the trajectory of the business looks like from here? Thank you so much.

Yes. Certainly, the first half was volatile as you said and there was quite a bit going on. And we still do expect a little bit of unpredictability in the short-term, but we entered the back half in good shape and with momentum. We have strong financial liquidity to invest in the brand. We have the opportunity to grow sales, improve margin and invest in the business. And we expect year-over-year sales performance to continue to improve versus the second quarter. And the reasons why we believe this is of our very unique strength, we have our purpose-led lifestyle brand and in times of uncertainty brands matter. And we are seeing that from our customers. We have size and scale, which plays out on multiple fronts and our omni capabilities. So, we believe we are advantaged to compete as we move into the second half. Katrina O’Connell: And then Kimberly, I think I would add. The cadence in the second quarter is helpful. From a store standpoint, as you remember, we were still reopening stores really starting in May into June. And we weren’t fully at 90% open until I guess late June and then July, and now we are fully 90% open. So, we have the dynamic of stores opening. The good news is our online business, I think you remember we said online was up 100% in May and then we reported online up 95% and so online, while benefiting a little bit in May from some shipping backlog really stayed strong as we reopened our stores, which we believe is a good sign of how the customer is responding to our brands and products. And as it relates to some of the net sales performance, I would say there is nothing else really to report with June and July sort of about the same. And so that’s sort of how the quarter played out. And I think you heard in the prepared remarks, how Sonia was describing back –to-school, there really is very different dynamic on where – we are just – we didn’t see the peaks in Q2 that we normally see on Memorial Day and July 4. People are just not shopping that way right now. It’s a very smoothed out curve of how things are happening, but we still have confidence that people are shopping for those occasions to shopping differently. Yes, I mean, we believe the demand will be there. Back-to-school is that family ritual. Families buy school supplies, they buy cool clothes to give kids confidence and whether they are learning at home or at school, we win in casual active and relevant products, so having the assortment that’s needed in any learning scenario, we feel confident in that and we have added to that with Gap Teen, Gap Kids Be The Future as well as Old Navy POPSUGAR collections. Look, everything has changed in this environment and things are definitely playing out differently around the world. And that said, we have the right to play and win in this space. And when customers are ready to shop and as we move further into the back half, we will be ready for the – with the fashion needs that they have. So, whether it’s back-to-school, which kids represents about 25% of our overall assortment, whether it’s the broader back half, I think that the resiliency and the capabilities that we have honed in on give us that momentum and confidence as we move through.

Really good color. Thanks, ladies.

And next, we will go Kate Fitzsimons from RBC Capital Markets. Your line is open.

Yes, hi, thanks very much for taking my question. I guess two quick ones here. It was interesting in the slide deck you guys noted that 10% of the revenue came from enclosed malls, I believe you guys often speak about the 70% of the fleet is off-mall. I guess just directionally with these closures relative to that 10%, where do you see enclosed malls shaking out as a percent of sales in 2020 over time? And then next shift really quick on Old Navy, obviously 2020 is a whole new bag, but when we think about a return to a normalized, call it, mid to high teens EBITDA margins how do you think about that with the shift to e-com that you are seeing and greater shipping expenses etcetera? Thank you. Katrina O’Connell: Yes, Kate, I will start, first and foremost and just let you know that we are going to give you a little bit more color on the breakout of what our end state fleet looks like as it relates to the type of mall versus off-mall. But I think it’s fair to say that since the lion’s share of the closures we are talking about are really Gap brand and Banana Republic that those will mostly be focused in the mall location, but where that shakes out, we will provide that hopefully more insight to you in the October call.

Yes. Let me add some color about Old Navy as e-com and pressure. Look, we have been in the e-com business for 20 years, and that has given us the ability over that time to build differentiated capabilities. We have a lot of automation, we have a lot of scale and in the value stays is the big advantage for us. And because we are a category killer in apparel, we have fine tuned and honed our fulfillment and logistics supply chain to optimize and lower costs. And so we feel poised and differentiated there, as we fuel this e-com business in the value phase, a couple that with a strength level, maybe product margins, and the advantage of the real estate format and cost of real estate. We think that the economic model for Old Navy, which we will share more in October, as Katrina says, gives us a lot of confidence.

Great. Thanks very much.

And next, we will go to Ike Boruchow from Wells Fargo. Your line is open.

Hi, everyone. Thanks for the question and thanks for letting me ask the question. I guess two questions from me. Just, I know you can’t really talk about margins in the back half, because the sales are so volatile, but maybe you could turn this on the merchandise margin. Could you give us a little bit of clarity on maybe what you currently think is reasonable to expect on the future in the back half or probably you want to characterize it And then just maybe some of the bigger picture, you guys have the portfolio of brands, some are underperforming, some are outperforming, some have grown from a shrinking and how do you think about them all working together and how do you think about your portfolio long term on – in terms of what – of how the Gap portfolio should look? Thank you. Katrina O’Connell: Yes. So Ike, to you first question, I hope you caught given in the speech that we were actually quite pleased that in the second quarter, we were able to realize improved product margins year-over-year as a result of lower discounting, particularly at Old Navy, Athleta and Gap. And we attribute that to the fact that we had the right product as well as great inventory management. And the teams are doing a nice job of managing promotions in the case of stronger consumer demand for our products. So the weight we had on our gross margins or merchandise margins in the quarter really were attributable to those pretty heavy fulfillment costs again driven by a combination of the dynamic of having to shift much of that demand from our stores combined with the increased online demand. And so as we think about the back half of the year, I would say, we will see where the product margins end up, but we have been quite frozen in the way we think about our inventory purchases. As you know, we have cut inventory substantially when the crisis first hit and we have been very purposeful about what categories we are chasing into and what brands we are chasing into in order to fuel that demand. And that combined with the fact that we do think we are investing in marketing behind our really relevant purpose-driven brands, we have lots of confidence that we can continue to see healthy margins in the back half. And then the dynamic on shipping, I think I described earlier, which is certainly, we will see elevated fulfillment cost associated with running more online business, but we do aspire to have a more moderated impact from having to ship from our stores.

Yes. Let me just add on to your second question, the management team and our board are highly engaged and attuned to investor considerations in looking at the portfolio, considering all opportunities for value creation. What I will say is that what’s different about us today is that we are leaner, faster, more focused Gap Inc. than prior. And I have never felt stronger than I do now in this moment that these four brands have the right to grow and that we expect to see tremendous potential within the portfolio. That’s what we are focused on. And we are focused on unlocking that value through strong execution, not divesting it. So, I feel great about the management team, the extended management team, and the commitment to this and we look forward to sharing more with you in October.

Thank you.

And our next question comes from Janet Kloppenburg from JJK Research Associates. Your line is open.

Hi, everyone and congrats on the progress. I am very interested in learning more about the Gap digital business, which is – seems to have taken off here while the stores continue to under-perform, perhaps you could help us understand a bit more of that and of the transfer rate you are expecting from the Gap store closures in the malls? And secondly, Sonia, when you think about the digital opportunity and the investments you are making there, how does that – how does that square with the opportunity to expand the brick-and-mortar base of Old Navy and Athleta something that we have talked about as a growth opportunity prior? Thanks so much.

Yes. Listen, I think Gap had a very solid quarter, the online demand was strong as you noted as customers flock to them. It’s a trusted known brand. And we saw improved execution across many, many fronts. It’s one of the highest store experience scores across the portfolio. The e-com business accelerated with great execution and the product resonated. We saw margin expansion, product acceptance and really all fueled by the focus on brand clarity and brand positioning. So we are pleased with the momentum we are seeing there. I would say, your comment around stores, what I would characterize is that we are walking away from unproductive sales in Gap brands and the stores that we are intending to keep in the fleet, we are expecting continued progress on and we are seeing that through customer feedback, through the conversion in our stores and raising the bar on ourselves in service to the customer. So, I’d say, Gap, we are taking to a leaner, more effective, well run, brand proud positioning and you start to see some of that shape in Q2. Katrina O’Connell: And then, Janet, I guess, I will just sort of add to your broader question. Strategically, we still feel like a well-positioned, profitable store is an advantage, especially as it relates to a growing online business, because we know that customers are shopping online, but they are also using our store fleet as an opportunity to come in and pickup or transact in a different way. And so we still see there being quite a virtuous relationship between stores online. And as the two brands that are looking to keep growing our store fleet are Old Navy and Athleta and they are being very purposeful in that growth. Old Navy continues to believe that they are under-penetrated compared to their competitive set in the smaller market, where their competitors are, but they are not. And so we will be prudent about watching that post-COVID, but we still think there is an opportunity to gain share there. And Athleta, still at only 50%ish brand awareness and under-penetrated in their store fleet don’t have an opportunity to open some stores here and potentially elsewhere. So more to come on that, but we don’t see that the two are necessarily in conflict. In fact, we believe there is quite a synergy there in those two channels.

Yes, I mean at our scale, the omni capability, the omni synergy winning in our e-commerce, in our stores through digital leadership is really where we think the sweet spot is.

Great. And lots of luck.

Thanks, Janet.

And next, we will go to Mark Altschwager from Baird. Your line is open.

Hi, good afternoon. This is Sarah Goldberg on for Mark. Thank you for taking my question. I wanted to ask on inventory flows, how are you positioned for fall in terms of the flow of fresh receipts and do you expect inventory to be a constraint or feel good about the ability to ship? Thanks.

Did you say, I missed, but you said flow…

Inventory flow. Katrina O’Connell: Okay, got it. So I think we feel good. We just reported that without the pack and hold inventory, we are down about 10% in our ending inventory. And we as I think I said earlier, we had cut a lot of inventory when the crisis hit, which in a way gave us the opportunity to really see how the customer is shopping and in what channel and in which brands, which product categories. So, we see this as an opportunity to have used our responsive levers and our speed capability to really get back into the brands that are performing well, particularly in Old Navy and Athleta as well as to influence the categories that are working, such as fleece and activewear, kids and baby etcetera. So, I think all of that said, we have been able to really position ourselves and then you have heard us say and then also in our online channel. So, we have used the opportunity to really leverage our capabilities to get the inventory hopefully where we believe the customer will be shopping.

Yes. And I will just add that we are – everyday we are getting faster and expecting greater speed and more agility. Some of the examples that come to mind for me in Q2 are the fact that with Old Navy growing active and fleece by 24%, when we have taken such a conservative play on inventory at the acute moment in the early part of COVID shows the speed with which we were able to chase that demand right to deliver that kind of results, essentially shaping into the product that customers wanted. And Athleta as well to grow 7% in the quarter required us to really fuel that with the right inventory. And the last example, my favorite one is talking about masks. I mean, we were able to go from 0 to 130 million due to the standup of a 5-week supply chain and these are just tangible examples of where we are shifting and the speed that we are expecting in order to be more and more responsive to customer demand.

Great. Thank you for all the color.

And next we will go to Matthew Boss from JPMorgan. Your line is open.

Great. Congrats on the nice quarter. So, two questions on gross margin on the 3Q improvements, is that less negative than the second quarter or you are forecasting actual gross margin expansion year-over-year in 3Q? And then Katrina, on SG&A as you dug into the model in each of the brands, is the goal as we should think about is to find cost savings that will flow to the bottom line or is it more to find opportunities to fund go-forward investments as we think about the magnitude of potential SG&A? Katrina O’Connell: Yes. So as it relates to third quarter gross margin, we are not guiding that specific dynamic. Hopefully, the commentary today has been helpful to you to understand that. We will see where sales land. But fundamentally, we believe the product margins as we saw in the second quarter are benefiting from strong product and strong brands. And so we will see how we compete in the back half. And similarly, we have talked about the fact that we do still have some headwinds on fulfillment costs. And again, we will see where that lands. So, we haven’t really been that specific. And as it relates to SG&A, I mean, we did use some pretty big moves in the first quarter, if you remember. We cut about 15% of our corporate overhead. And we have been focused on getting cost out of the system, but we were also trying to be helpful in our acknowledgment of the fact that frankly in this COVID environment, one of our bigger priorities is providing our customers a safe place to shop and that does come with higher operating expenses in the stores. The good news is as we have seen customers are coming back to our stores and they are providing us with good net promoter scores associated with feeling safe in our stores. So, we feel that’s important. And as I said, we are going to invest in marketing. We do feel like in this dislocated time in retail, it’s an important time for us to tell the stories of our four big brands that are competing well with the customers. And so again, we will see where that all plays out in the P&L, but that’s how we are thinking about the back half.

Great. Best of luck.

And next, we will go to Oliver Chen from Cowen. Your line is open.

This is [indiscernible] on for Oliver. Thank you for taking our question. Could you just provide more color on the new customer acquisition, you saw strong growth during the quarter and maybe which brand we saw the highest new customer acquisition via online and how are you planning to drive repeat purchases from these customers? Thank you very much.

Yes. I mean, we are really thrilled about the customer growth, 165% growth in new online customers’ acquisition year-over-year. Of course, because of Old Navy’s size, the distortion was in Old Navy, but we saw customer growth across the board in e-commerce. And so, again the advantage we have with this massive customer file that’s growing in a differential way in e-commerce, you couple that with value-centered brand management and really owning these brands that have greater purpose and connect to customers in a time of complexity, I think it’s a very uncertain time. Our brands are connecting even more greatly and we are telling stories with greater focus on that connection, it’s that combination, it’s that intersection that we are finding that we can differentiate.

And next, we will go to Susan Anderson from B. Riley FBR. Your line is open.

Hi, good evening. Thanks so much for taking my question. I was wondering if you maybe could expand a little bit just on your thoughts on back-to-school, it sounds like you expect the season to be prolonged, which makes sense, but I guess if you think that there is going to be some lot sales or is it really just kind of a change in catalyst towards more of a weather event versus back-to-school, then I guess more across Old Navy and Gap?

Yes. We are not seeing the typical peaks in the COVID environment over the course of the last many months. People are shopping over a longer period of time. And so we expect back-to-school to be smoothed out over the coming weeks and months versus an acute moment in August like in prior years. We saw very similar behavior like this around Memorial Day and 4th of July shopping. That being said, customers are still shopping for those essential products, whether it was summer product back then. And so we have had experience now managing though these peaks and showing up in a different pattern. We are prepared to service that need whenever the customer is ready to shop. And we believe the demand will still be there. Back-to-school as I said is that family ritual and families want to buy their kids relevant clothing to give them confidence, whether they are learning at home or school and we will win as we do with casual active and cool assortments. And so we have got the assortment that’s needed and we are ready to serve our customers as she engages with us in back-to-school.

Thanks so much.

And next, we will go to Dana Telsey from Telsey Advisory Group. Your line is open.

Good afternoon, everyone. As you see the progress in Old Navy that you have made and I know, Sonia, you have always talked about category opportunities there. Where do you see the Old Navy opportunities coming from? And do you see it as a margin and pricing and AUR opportunity also? And then on the Athleta business, any changes in how you think seeing that assortment and merchandise margin opportunities there, too? Thank you.

Yes. I mean, let me zoom way out and first start by saying we characterize – I characterize 95% of our Gap Inc. assortment to be relevant to how customers are dressing today. We have always led the way with casual and comfort and optimism which was people – which is what people are looking for right now in their assortment. So that feels overall very good. Specific to Old Navy and I thought what I will say is the active – an active lifestyle dominance that they both have has been a massive differentiator. The Old Navy grew its active and fleece business by 24% in Q2 versus last year is now north of $1 billion business. I think it represented roughly a $300 million business alone in Q2 and Athleta also very dominant across the gamut of their categories, as they really play to that lifestyle that active and athleisure lifestyle. So that is the category space and but again, really the underlying that – underlying the premise is comfort and casual. And we believe that applies to all of our brands and certainly, Gap brand won with knits and hoodies and other product types, because of casual and comfort at Banana Republic, with their niche products as well as some of their more work leisure as we are calling it oriented products. So, the uber point is we have authority here, we always have it’s really how we had built our business over decades. It’s leading with the casualization of American style. And so this next wave is active and we are riding that wave.

Got it. And do you see margin opportunities for each of those businesses as a result of this?

Yes. I think that we are pleased with the product expand – product margin expansion in Q2 and we will continue to compete for that as we move into the back half.

Thank you.

And next, we will go to Alexandra Walvis from Goldman Sachs. Your line is open.

Good evening. Thanks so much for taking the question. I have couple of questions from me. The first is on whether you can share any more color on traffic trends, perhaps sharing any color on the discrepancies between the different banners, between different geographies and indeed different formats, how that shapes up versus conversion in the store?

Yes. So as it relates to traffic, I think what we said earlier is that similar to the dynamic we described last quarter, Old Navy’s locations are benefiting from the better trends. And Banana is suffering the most. That said, the other dynamic we are seeing is that traffic is sort of hard to look at and those people who come in are highly qualified buyers. And so we are seeing stronger sales over traffic trends for people who come in really with a purpose to buy. But again, traffic is a little different, because a lot of the traffic is starting online, there is curbside pickup. It’s just a different omni channel dynamic. But fundamentally, on a scale I would say Old Navy is the best and then Banana, just based on its product category right now is the weaker of the brand. And what I will say is we pivoted to purpose led brand marketing and you saw examples of that in Q2, whether it was the We Are We advertising from Old Navy or the Be The Future advertising from Gap brand or the Athleta advertising celebrating female empowerment. As we have zoned in on that on purpose-driven marketing, we have seen that positively impact traffic and flow into both channels.

Perfect. Thank you, Sonia. Thank you, Katrina.

That does conclude our call. And as always, we will be available for any further questions and we hope everyone stays safe and healthy.

Thank you. That does conclude our call for today. Thank you for your participation. You may now disconnect.