Gap (GPS) Q2 2023 Earnings Call Transcript

Gap (GPS 5.59%)
Q2 2023 Earnings Call
Aug 24, 2023, 5:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good afternoon, ladies and gentlemen. My name is Brianna, and I will be your conference operator today. I would like to welcome everyone to The Gap, Inc. second quarter 2023 earnings conference call.

At this time, all participants are in a listen-only mode. [Operator instructions] I would now like to turn your call over and introduce your host, Emily Gacka, director of investor relations.

Emily Gacka -- Director, Investor Relations

Good afternoon, everyone. Welcome to Gap, Inc.'s second quarter 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-K 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 gapinc.com.

These forward-looking statements are based on information as of today, August 24, 2023, and we assume no obligation to publicly update or revise our forward-looking statements. Joining me on the call today are executive chair, Bob Martin; chief executive officer, Richard Dickson; and chief financial officer, Katrina O'Connell. With that, I'll turn the call over to Bob.

Bobby Martin -- Chief Executive Officer

Thank you, Emily, and good afternoon, everyone. Before Katrina shares our second quarter results, I have the pleasure of welcoming our new chief executive officer, Richard Dickson, to the call. There's no denying that Richard was destined for this role at this moment. His experience as a transformational brand builder makes him a perfect fit for this great company.

He's uniquely qualified to lead and carry out the transformative work already underway. And more importantly, he is the right leader for tomorrow, defining the future for Gap, Inc. Appointed to our board of directors in November of 2022, he's had a view into how we are changing the way we work and the results we deliver. But what energizes him most is building a new legacy for our renowned portfolio of brands, one that matters to our customers, employees, and shareholders.

And before I hand it off, I want to say thank you to our entire Gap, Inc. team for their commitment to the success of this company and their tenacity and care for our brands, for embracing operational rigor and regaining the product and customer obsession, with an eye on modernizing the way we work, all of which becomes a strong foundation for what's ahead under Richard's leadership. I have great belief that Richard and this team will define a very bright future for this company. So, with that, I want to welcome Richard Dickson, the new chief executive officer of Gap, Inc.

Richard.

Richard Dickson -- Chief Executive Officer

Well, good afternoon. This is my third official day as CEO of Gap, Inc. So, first, let me begin by thanking Bobby, the board, and the entire Gap, Inc. organization for the opportunity to lead this incredible company.

And thank you, everyone, for joining us today on our second quarter 2023 earnings call. Now, many have asked me why Gap, Inc. and why now? So, let me start by saying that I have admired Gap, Inc. and its brands, Old Navy, Gap, Banana Republic, and Athleta, for decades as a customer, a brand builder, and most recently, as a board member.

Those of you who know a bit about my career know that I've always been drawn to companies and brands with storied legacies and powerful purposes. And in apparel, there's no equal to Gap, Inc. When Don and Doris Fisher opened the very first Gap store in San Francisco in 1969, little did they know that they had tapped into the zeitgeist in a way that would democratize and define American style. Suddenly, great clothes were accessible.

Stores were experiential. Self-expression could be an everyday pursuit, open to all. Talk about a game changer. Gap did that.

Creating an opportunity from the currents of culture has been a hallmark of Gap, Inc. for more than five decades. Over the years, our brands made jeans, khakis, kids wear, suits, yoga pants, you name it, into massive trends through great design, great marketing, and an all-out obsession with our customer. Fast forward to today, the apparel and retail landscape has changed dramatically.

Evolving at an even quicker pace now, it requires that great brands run at the speed of culture to maintain relevance. What has not changed is the customers' desire for fashion that they can make their own. We will take that one step further, making what we do, what we stand for, and what we sell relevant. As anyone in this industry will tell you, clothing is a rational need while fashion is an emotional want.

Our brands will balance both. Going forward, I'm confident that we have the scale, talent, and determination to spark huge defining trends again. Think about it. Gap, Inc.

is the largest specialty apparel company in America, an empowered community of more than 90,000 people who apply their talents to Gap, Inc. and our brands, producing about 900 million units a year. Our brands draw 600 million visits to stores and 1.4 billion to our sites online each year, making Gap, Inc. the No.

2 player in U.S. apparel e-commerce. These customers across multiple generations turn to Old Navy, Gap, Banana Republic, and Athleta to help them step out everywhere, from schools and studios to offices and date nights. So, our brands matter, but they can matter even more.

In my previous role in toys and entertainment, we always strived to make consumers fans and to grow those fandoms, and I want to apply that approach to our portfolio of brands, a virtuous cycle where our products and experiences motivate belief and loyalty that fans then badge and amplify in culture, growing the fandom, validating and inspiring us to even greater creativity and monetization. It works because everyone wins. Gap, Inc. brands already have incredible fans.

Our job now will be to excite and delight them even more, growing their numbers and the value of our brands. The comprehensive transformation effort that Bobby initiated has been an important step in that direction, streamlining operations so that we could focus on growth-driving initiatives. And Katrina will take you through that progress, in addition to the quarterly performance, in detail. But before she does, I want to acknowledge that restructuring is challenging and that change of this magnitude doesn't come fast.

Transformation is difficult. Still, our people at every level of the organization have stepped up, made tough calls, and championed the progress we've made so far. And we're going to keep going. As we continue to focus on strengthening our financial footing, we're now going to build on that progress, accelerating our efforts to drive profitable growth by unlocking the value in our brands.

This time, we'll do it differently, with a clear focus on brand revitalization, redefining our brand's meaning to consumers, focusing on creativity, designing for relevance as a pursuit rather than a goal, building to quality, and leveraging our remarkable legacy to shape an exciting new future. That's my passion. It's why I'm here and why I'm here now. And I know that our teams are just as passionate and committed to making it happen.

In the quarters to come, I'll share specific priorities and plans. What I can tell you today is that I'm intent on reigniting a creative culture at Gap, Inc. that is a magnet for the industry's best talent, including the great creative talent we already have; recommitting each of our brands to a distinctive brand purpose that aligns with customer values and sets them apart; reorienting our brands around both the art and science of design-centric thinking, informed by consumer insights and an absolute obsession with our customer; reengaging in the cultural conversation with hyper-relevant products and ideas that inspire constructive dialogues; and rethinking how our brands show up in store and online, with customer experiences that excite and delight; most of all, mattering to our people, our investors, our communities, and the world. In the coming weeks, I look forward to spending time in every part of the organization, our headquarters' offices, stores, customer support centers, DCs, and with partners in key regions of the U.S.

and globally, meeting the people behind our brands, the customers who shop us, and you, our shareholders, listening, learning, experiencing it all firsthand in order to get grounded and even more defined about where we're going. I'll wrap up by saying that my start date was deliberate. Just as August 22, 1969 was the milestone that created this remarkable company, I want August 22, 2023 to mark the start of an exciting new chapter for Gap, Inc. One that celebrates our past as we pioneer an extraordinary future.

Thank you, and I'll now hand off the call to Katrina.

Katrina O'Connell -- Executive Vice President, Chief Financial Officer

Thank you, Richard. It's been a pleasure working with you in your role as a board member over the past nine months, and I'm thrilled to partner with you in your new role as CEO. Let me start with some reflections on our financial performance before I dive into more detail. Notably, we continued to strengthen our balance sheet and improve cash flows, reducing inventory 29% year over year, generating over $300 million of free cash flow, further paying down our ABL balance, and ending the quarter with cash and equivalents of $1.4 billion, nearly twice as much as last year.

Even in a choppy consumer market, each of our brands maintained or gained share during the quarter, fueled particularly by strength in our women's business through great style and relevant fashion. We delivered net sales within our previously communicated guidance range despite a weak and peril environment. We substantially completed the organizational changes that we previewed earlier this year, which we continue to expect will drive about $300 million in cost savings annually but, more importantly, will change how we work, allowing teams to be more consumer-centric. We continue to successfully recoup the excess air costs we incurred during the pandemic.

That, combined with improved unit sell-through rates driving AURs, enabled meaningful gross margin expansion despite the inflationary cost headwinds we have faced. And we believe the actions to improve our operations and shore up the foundation of Gap, Inc. continue to position us well as we enter the second half of fiscal 2023 and beyond. While we're pleased with this progress, we're mindful of the mixed economic and consumer environment in which we are operating.

With that backdrop, we continue to plan the business prudently, and the outlook we're providing today for both the third quarter and fiscal 2023 does contemplate the headwinds we continue to navigate in the second half of the year while also taking on new challenges like the resumption of student loan payments. Let me start now with our second quarter results. Net sales of $3.5 billion decreased 8% versus last year, in the range of our expectations for second quarter sales to be down mid to high single digits. Store sales decreased 7% from the prior year.

Online sales decreased 11% versus last year and represented 33% of total net sales in the quarter. As a reminder, the sale of Gap China completed at the beginning of the first quarter of fiscal 2023 had about a $60 million or 2-point negative impact to net sales growth. There was also a 1-point foreign exchange headwind. Excluding these factors, total company net sales would have been down about 5%.

Comparable sales were down 6% in the quarter. In spite of the sales declines, we're pleased to report that all four of our brands gained or maintained market share during the second quarter, with particular strength in women's. We know that regardless of market conditions, strong brands, brands that matter win, so we remain focused on the levers and opportunities in our control to deliver on behalf of our customers, employees, and shareholders. Let me now provide some sales color and highlights by brand, starting with Old Navy.

Net sales in the second quarter were $1.96 billion. Both net sales and comparable sales declined 6% versus last year. We're pleased that Old Navy again modestly gained share in the quarter despite increased softness in the active category, as well as continued slower demand from the lower-income consumer. We believe that Old Navy remains well positioned given its value orientation in the marketplace.

The Old Navy team has lined up great marketing product and value to compete in the important back-to-school season. Turning to Gap brand. Gap brand total sales of $755 million were down 14% versus last year and comparable sales were down 1%. Excluding the negative impacts to sales of 7 points related to the sale of Gap China, 2 points due to the shutdown of Yeezy Gap, and the estimated 1 point from foreign exchange, net sales were down 4% versus last year, predominantly driven by store closures in North America.

Women's was the standout segment in the quarter, outpacing the market, as the brand's reinvented icons are resonating with consumers. Gap continues to make great strides with exciting collaborations and partnerships as the brand executes against its strategy to reimagine its product icons in new and exciting ways. Earlier this month, Gap brand partnered with LoveShackFancy on a limited-edition, multicategory capsule for every generation. The collaboration merges Gap's iconic styles with LoveShackFancy's vintage-inspired florals and feminine silhouettes.

This most recent collaboration is a prime example of how Gap's strategy of partnering with relevant brands and individuals can create buzz and marketing for the brand, reaching new consumers and garnering more premium pricing. Turning to Banana Republic. Second quarter sales of $480 million declined 11% year over year. Comparable sales were down 8%.

Revenue remains impacted in the short term as the brand laps an outsized benefit last year, driven by the dramatic shift in customer preferences. BR continues to make impressive strides in its evolution to a premium lifestyle brand. Fine fabrics like linen, cashmere, and leather showed signs of strength in the quarter, and the brand expects to maximize them in the back half of the year. Banana Republic's transformation toward a more evolved lifestyle position is coming to life through an elevated fashion aesthetic and more full-price selling.

As we look to the future, we're excited to see the brand extend its vision and refined aesthetic to other addressable markets with BR Home, including the launch of premium bedding, rugs, pillows, and decor in March and the upcoming debut of a broader home offering this fall. Athleta sales of $341 million declined 1% from the prior year. Comparable sales were down 7%, an improvement in trend from Q1. Sales in core performance bottoms, the critical backbone of Athleta's assortment, accelerated throughout the quarter and outperformed total brand sales.

Athleta's positioning, empowering a community of active women and girls to reach their true potential through the Power of She, is as relevant and impactful as ever. The work the team has been doing to improve product presentation, customer experience, and creative in the short term, optimizing online marketing, site merchandising, and resetting store floors in key markets emphasizes the performance DNA that Athleta is known for. We're really excited to welcome Chris Blakeslee to the team. As a proven leader in driving growth and innovation in the active apparel and wellness sector, most recently at Alo Yoga, we look forward to the work he and the team will drive to bring the Athleta brand to its full potential over the long term.

Now, turning to gross margin in the quarter. Gross margin was 37.6%, an increase of 310 basis points versus last year's reported gross margin. Compared to last year's adjusted rate, gross margin expanded 160 basis points due to merchandise margin expansion of approximately 260 basis points, which was slightly ahead of our expectations, partially offset by ROD deleverage of 100 basis points. Drivers of the margin rate expansion were as follows: approximately 200 basis points of leverage as we lapped last year's elevated air freight and drove our normalized air expense down; approximately 200 basis points of leverage, driven primarily from improved promotional activity relative to last year; approximately 140 basis points of deleverage related to inflationary cost headwinds, which was better than our prior expectations of approximately 200 basis points as we realized improved ocean freight rates; and ROD was flat on a nominal basis compared to last year but deleveraged 100 basis points due to the lower sales volume.

Now, let me turn to SG&A. Reported SG&A in the second quarter was $1.2 billion and included $13 million in restructuring charges related to our headcount actions. On an adjusted basis, second quarter SG&A declined 8% and leveraged 10 basis points versus last year, driven mainly by lower advertising expense, payroll, and technology investments. Reported operating income was $106 million.

Adjusted operating income, which excludes restructuring charges, was $119 million in the second quarter. Adjusted operating margin improved 170 basis points from last year to 3.4% in the quarter, driven by the 160-basis-point improvement in adjusted gross margin and 10 basis points of adjusted SG&A leverage. During the second quarter, we recorded a benefit to both tax and net interest as a result of a transfer pricing settlement related to our sourcing activities. Reported EPS was $0.32.

Adjusted EPS, which excludes restructuring charges, was $0.34. Share count ended at 369 million. Turning to balance sheet and cash flow, starting with inventory. Ending inventories declined 29% in second quarter versus last year.

This includes a 9-percentage-point decline related to in-transit as we lapped the prior year's supply chain challenges and 6 points of decline related to releasing the majority of our pack and hold inventory balance. The remaining 14-point decline was driven by more efficient inventory management. As you know, we made significant progress on reducing inventories as we exited fiscal 2022. We remain focused in fiscal 2023 on moderating buys and utilizing our responsive levers.

As a result, we are planning for year-over-year inventory to be down generally in line with year-to-date trends at the end of third quarter. Quarter-end cash and equivalents were $1.4 billion, an increase of 91% from the prior year. Year-to-date net cash from operating activities was $528 million, driven primarily by lower inventory levels. Capital expenditures were $199 million.

We are pleased to have generated free cash flow of $329 million year to date. As we told you last quarter, we expect to be positioned to pay down the $350 million draw on our asset-backed line of credit this year. During the quarter, we paid down $200 million and intend to pay down the remaining $150 million balance by the end 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 August 16th, our board approved maintaining that $0.15 dividend for the third quarter of fiscal 2023. Now, turning to our outlook. We are all well aware of the mixed economic data and uncertain consumer trends in the marketplace, including the new dynamic regarding student loan repayments beginning in the third quarter.

As a result, we continue to be prudent in our approach to planning in light of what remains an uncertain macro environment and choppy consumer backdrop. We now anticipate fiscal 2023 net sales, inclusive of the 53rd week, to be down generally in the mid-single-digit range compared to $15.6 billion in net sales last year and similar to our first half 2023 sales performance. The extra week is estimated to add approximately $150 million to fourth quarter and fiscal 2023 net sales. Specific to Q3 sales, we're encouraged by trend improvements as we exit second quarter and into August.

However, we remain mindful of two important dynamics for the quarter. First, we are lapping tougher sales comparisons from last year. And second, as mentioned, we remain measured in our outlook. With these dynamics in mind, we are estimating third quarter net sales to be down in the low double-digit range compared to the $4.04 billion in net sales last year.

Turning to gross margin, starting with the full year. Compared to the 35% adjusted gross margin in fiscal 2022, gross margin expansion in fiscal 2023 is expected to be driven by the following factors: an estimated 200 basis points of leverage as we lap last year's elevated air freight and continue to drive down normalized air expense, at least 100 basis points of margin benefit as a result of our better inventory position and expected improved promotional activity compared to last year, approximately 10 basis points of inflationary cost deleverage versus last year. As we look to the second half, we expect the inflationary deleverage in the first half of the year will shift to leverage in the back half as we benefit from both improved commodity costs and ocean freight rates. And ROD as a percentage of sales is now planned to deleverage roughly 70 basis points compared to last year.

For the third quarter, we expect gross margin to be generally in line with last year's adjusted gross margin of 38.7%. We anticipate lower inflation and air costs slightly below normalized levels are expected to offset approximately 150 basis points of ROD deleverage, and we expect that promotional activity will be largely in line with last year. Turning to SG&A. We now expect fiscal 2023 SG&A of approximately $5.15 billion, below our prior outlook of $5.2 billion, primarily driven by variable expense flow-through on our narrowed fiscal 2023 sales.

SG&A in the third quarter is expected to be approximately $1.3 billion. We continue to expect capital expenditures of approximately $500 million to $525 million for the year. In closing, we're pleased to drive meaningful margin expansion and strong cash flow generation in the quarter and remain focused on delivering our fiscal 2023 outlook despite what continues to be a choppy consumer environment. I'm looking forward to working with Richard and the team as we unlock the value of our important and iconic brands and position Gap, Inc.

back on its path toward sustainable profitable growth and delivering value for our shareholders over the long term. With that, we'll open up the call for questions. Operator.

Questions & Answers:

Operator

Thank you. [Operator instructions] Our first question will come from Matthew Boss with J.P. Morgan. Your line is open.

Matt Boss -- JPMorgan Chase and Company -- Analyst

Great. Thanks. So, maybe a two-part question. Richard, could you elaborate on the encouraging signs of progress that you see across the organization and maybe just as we think about opportunity for your concepts to take market share over time? And then, Katrina, maybe just any way to elaborate on trends that you saw progress as the second quarter moved forward and maybe what you're seeing today in terms of consumer behavior in August and into back to school?

Richard Dickson -- Chief Executive Officer

Well, first off, thank you, Matthew, for the question, and I'll start with saying again how excited I am to be here on my third day. What I can tell you in the context of where we are, first and foremost, is that these brands are incredible assets. Gap, Old Navy, Banana Republic, Athleta, these are truly some of the most iconic brands in the fashion industry. We serve such a broad-based consumer, which is such a strength as well, generations and backgrounds.

We've got incredible storied legacies, 54-year-old history. We've created massive trends. You know, when I look at the strength across the portfolio, as I mentioned in my opening remarks, you know, we're the No. 1 specialty apparel company in America.

The scale that we operate, with 600 million store visits, you know, 1.4 billion online visits. The scaled operations we have from our DC network and logistics. Our vendor partnerships, which can provide us incredible favorable rates and service. Our production, we produced over 900 million units annually.

The stats and strength of the fundamentals of this business are pretty incredible. Clearly, the transformation work that the team has done has put us on incredibly better financial footing. As Katrina mentioned, again, 1.4 billion in cash on hand on the balance sheet, 300 million of cash flow, 30% less inventory. These are metrics that matter and ultimately metrics that are incredibly encouraging in the context of our ability to build upon it and continue it and go forward.

As I also mentioned, part two to the question in terms of where are the opportunities, you know, these are brands that truly matter. Now, as I also said, they can matter more. In the how to do that, you know, I talked about reigniting the creative culture at Gap. We have extraordinary talent here.

We are going to not only encourage the great talent to be unlocked in new and innovative ways, but we're also going to become a magnet for the industry's best talent. We are going to work very specifically with intent on creating distinctive brand purposes and ultimately really driving a consumer proposition that sets us apart from the competition and really leveraging, if you will, the art and science of this business, informed by consumer insights, but ultimately really obsessing over the consumer. There's a lot of work ahead, but I'm incredibly encouraged with three days in around what we can offer and where we're going ahead. And obviously, in the days ahead, quarters ahead as well, we'll get more details and look forward to sharing that with you.

Katrina O'Connell -- Executive Vice President, Chief Financial Officer

Thanks, Richard. And, Matthew, I think on your other part of your question, we saw sequential improvement throughout the quarter in Q2, where in July, we definitely saw more improvement than we had seen sort of in May and June. I think that mirrored a lot of what apparel showed overall. And we've seen that improvement continue into August, which we're encouraged by.

Overall, what we're seeing is that the women's business, particularly at Gap and Old Navy, has shown momentum shift; and kids and baby, as we're in the important back-to-school period, has also started off fairly well. So, all of that is encouraging to see. And then as I said in my prepared remarks, you know, we're mindful, though, of the fact that we've seen the consumer still be pressured, especially at the low-income range. And we're watchful of what I think is widely reported as the student loan repayment coming in the end of the quarter, which does primarily impact our Old Navy consumer.

Matt Boss -- JPMorgan Chase and Company -- Analyst

It's great color. Welcome aboard, Richard.

Richard Dickson -- Chief Executive Officer

Thank you.

Operator

Our next question comes from Paul Lejuez with Citi. Your line is open.

Paul Lejuez -- Citi -- Analyst

Hey. Thanks, guys. Richard, you've been on the board, so obviously in touch with what's been going on operationally, to some extent. So, I'm curious what do you think might be the lowest hanging fruit as you think about each of the brands? Also curious, you know, big organization, you talked about the scale.

Profitability doesn't quite match the efficiencies you would expect with such scale. So, I'm curious what you think are the biggest inefficiencies of the company. Thanks.

Richard Dickson -- Chief Executive Officer

Yeah. Thanks, Paul. Look, broadly speaking, it's about really reigniting Gap, Inc.'s culture to really empower creativity. You know, in my experience on the board and certainly on the ground for three days running fast, our teams are incredibly creative and they're all in on this.

They're differentiating and strengthening our brands, being design-centric, being customer-obsessed, and ultimately being culturally relevant. These are not necessarily new phrases, and they're common language, but these are the areas that we need to work upon and reignite and ultimately really, you know, think about how our brands show up in store, online with consumer experiences that really excite and attract, drive demand. And all of the variables that go into kind of balancing wants and needs, that, ultimately, is kind of where fashion lies. When I think about our brands in the context of opportunity, you know, brands that have the kind of strengths that we do, brands that matter can be monetized.

We need to make these brands matter more. And ultimately, that is going to be the pursuit. When I look at the strengths of the business, it is incredibly encouraging. That being said, we have work to do.

You know, we've started this transformation work under Bobby's leadership, and the team has worked tirelessly to make extraordinary progress. But we will continue not only the transformation that we've begun, but we will start to build upon it and really unlock the value of these brands. We can all agree that there is greater value in the portfolio than is showing up in the stock today. And with the consistent performance that we expect, we're going to get rewarded for that.

And ultimately, that's going to start with really driving demand, exciting our consumers, and mattering more. And we'll be back very shortly to share how we're going to reveal all of that and continue moving forward.

Paul Lejuez -- Citi -- Analyst

OK. Thanks. And, Katrina, can you just talk about what changed in your gross margin assumption for the back half of the year, which pieces moved as a result of what you've seen first half to date, and what you're seeing thus far in the third quarter? Thanks.

Katrina O'Connell -- Executive Vice President, Chief Financial Officer

Yes. Absolutely, Paul. So, in second quarter, overall, the gross margin in total came in very close to, I think the words we had used to get you guys, close to the margin we just delivered. There was a little bit of a shift between the inflationary pressure, which was better, came in at about 140 basis points of headwind.

We had thought it would be closer to 200. And that was really because we saw rates in the freight area get better through some negotiations we just finished with some of our big suppliers. And where we saw the margin get a little worse was in ROD, where we deleveraged more since we came in at the lower end of our sales range in the quarter. So, that dynamic plays through to the year where, again, the overall guide on the full year margin is basically intact.

Air is still about 200 basis points of benefit. But we now see less impact from inflation. So, only 10 basis points versus we had prior said 50 basis points of headwind. And then the offset there is ROD, where we now expect 70 basis points of deleverage, whereas we had said somewhere between 0 and 50.

So, it's really this inflationary benefit offset by ROD deleverage. But overall, the nominal guide is very similar.

Paul Lejuez -- Citi -- Analyst

And the promotional level is different than what you expected in your assumptions?

Katrina O'Connell -- Executive Vice President, Chief Financial Officer

We came in very close in the second quarter to what we expected on promotions. And overall, we're holding the full year to about 100 basis points of overall leverage coming out of that promotional guide. And for third quarter, what we said is we expect promotions to be about flat. So, you know, we'll see.

Obviously, we came in with inventories down 29%, markdown inventory well under control, and the teams are excited to have chase capability back after the supply disruption that we experienced for so long. So, we'll aspire to do better, but right now, that's what's embedded in the guide.

Paul Lejuez -- Citi -- Analyst

Thanks. Good luck.

Operator

[Operator instructions] Your next question comes from Alex Straton with Morgan Stanley. Your line is open.

Alex Straton -- Morgan Stanley -- Analyst

Perfect. Thanks for taking the question. Welcome, Richard. Katrina, maybe this is best for you.

It looks like Old Navy has yet to inflect, though we are seeing some other value-oriented businesses pulling that off, it seems, in this quarter. So, can you talk about what's going on there? Are you seeing any green shoots outside of women's? I feel like we've had that maybe for a couple of quarters now. And then how do you think about the timeline to improvement? Thanks a lot.

Katrina O'Connell -- Executive Vice President, Chief Financial Officer

Yeah. It's a great question, Alex. So, when I look at what's been happening at Old Navy, I think what's been consistent is what we've been calling out, which is they do have a low-income consumer that remains pressured. And so, that dynamic hasn't necessarily changed.

When I look at what happened in Q2, though, lapping last year's significant clearance of active product, in particular, really weighed on the performance. If you remember, last year, in Old Navy, we were in the process of really rightsizing the assortment away from cozy casual. We had a lot of the sizing issues. So, lapping that has really weighed on the revenue side of things.

As we move into the second half, we are seeing the active business improve modestly. Women's is getting better and kids is looking better as well. So, we'll see where that all lands us. But yeah, we are seeing green shoots at Old Navy.

I think all of those categories, we aspire to have getting better. Again, the consumer pressure is most acute at Old Navy. And that's the piece that I think we all remain cautious on is whether it's the low-income consumer starting to get real wage pressure from inflation or whether it's the new student loan dynamic, we'll see how that plays out for Old Navy.

Alex Straton -- Morgan Stanley -- Analyst

Thanks a lot. Good luck.

Katrina O'Connell -- Executive Vice President, Chief Financial Officer

Thanks, Alex.

Operator

Our next question comes from Lorraine Hutchinson with Bank of America. Your line is open.

Lorraine Hutchinson -- Bank of America Merrill Lynch -- Analyst

Thank you. Good afternoon. Katrina, as you think about the mid-single-digit decline in sales guidance for the year, it does imply a nice improvement in fourth quarter. Can you just talk about how you've been thinking about that improvement, what drives it outside of the 53rd week, of course, and how you're getting comfortable with that level of improvement from here?

Katrina O'Connell -- Executive Vice President, Chief Financial Officer

Yeah. So, Lorraine, you're correct that the fourth quarter does have some benefit from the 53rd week. But in addition to that, I know we're all tired of looking back at 2019, but I just sort of look at the run rate in the business from the first half to the back half versus 2019 and the quarters Q3 and Q4 are very similar to what we just sort of went through. So, I think there's a lot of quarterly variation that we have seen over the last couple of years.

Fourth quarter, when you look back to 2019, looks more similar to history.

Lorraine Hutchinson -- Bank of America Merrill Lynch -- Analyst

Thank you.

Operator

Our next question comes from Jonna Kim with TD Cowen. Your line is open.

Jonna Kim -- TD Cowen -- Analyst

Thanks for taking my questions. Just touching on Athleta, sort of how you're thinking about turning around the brand and getting the brand back on the growth over time and just be competitive in the market? Thank you so much.

Katrina O'Connell -- Executive Vice President, Chief Financial Officer

Yeah. I'll take that. And I mean, Richard, of course, I welcome your view as well, but maybe I'll start, and then you can say a little bit more. As I said in my prepared remarks, we feel really good about Athleta's positioning in the marketplace.

The Power of She positioning is incredibly strong, and we feel like we have a lot of white space in that brand to win. We knew we had some near-term product execution issues, which the team, as I said, has been heads down working on. For fall, there's not a lot of change to the product that the teams have been able to do, but they've been remerchandising the stores and the site. And hopefully, if you're a consumer, you see that it looks much more in line with the brand aesthetic.

And then we are excited to welcome a few new players to the team, whether it's Chris or Julia, who we think will also bring their experience to bear on the brand starting in fourth quarter and then really into next year. So, we're very excited about Athleta's potential long term, and we know we're just sort of going to get through the next quarter or two as we make the changes we can to the assortment we have. But, Richard, I'll let you add if there's something else.

Richard Dickson -- Chief Executive Officer

Yeah. Thanks, Katrina. Jonna, you know, as a member of the board, I had a chance to get to know Chris and to help select him for this role. He's an exceptional talent, broad-based experience across the apparel retail and wholesale industries, holding roles across multiple functions.

As the recent president of Alo Yoga, he was really able to successfully and quickly grow that brand, nearly doubling its year-over-year growth and with extraordinary expertise in performance apparel. So, as Katrina called out, we couldn't be more enthusiastic about the team that Chris is leading and their recent efforts, and we're really looking forward to, you know, the accelerated progress that we intend on making with this brand.

Jonna Kim -- TD Cowen -- Analyst

Got it. Thank you.

Operator

Our next question comes from Bob Drbul with Guggenheim Securities. Your line is open.

Bob Drbul -- Guggenheim Partners -- Analyst

Hi. Good afternoon. And, Richard, welcome. I guess, Richard, for you, when you look at the -- you know, you talked about Chris, but when you look at the team that you have in place, you know, having been on the board is -- you know, I think you understand their vision.

Should we assume there are no further management changes necessary, you know, at a very senior level as you look at the portfolio?

Richard Dickson -- Chief Executive Officer

Yeah. Thanks, Bob, for the question. You know, I've been on the board since last year when much of the work began taking root, and I feel I could really hit the ground running. You know, that said, it's early.

I'm focused on listening and learning. We really do have a very strong team. I only see it getting stronger. So, in the context of, let's call it, board tenure and now obviously three days in, you know, from what I feel and see in the context of being on the ground, I'm very encouraged.

The work that the team has done around the transformation has really toiled the soil, if you will, in the context of my entrance, and really feel like the baton being handed is strong. So, with that said, we'll share a lot more in the coming quarters around where we're headed, how we're going to get there, and ultimately much more detail associated with it. But early days, I'm very encouraged.

Bob Drbul -- Guggenheim Partners -- Analyst

Great. And, Katrina, if I could just sneak a second one in for you. You made some progress on the SG&A. I know there's been some discussion around potential for further cuts.

Is there any sort of further idea on additional opportunities as you look at the SG&A line going forward?

Katrina O'Connell -- Executive Vice President, Chief Financial Officer

Yeah. It's a good question, Bob. I mean, when we look at the work we've done, we've impacted about $550 million of a cost in the business, whether it's the actions we took early last fall that have helped offset some of the inflationary pressure this year or whether it's the overhead actions we just took that we think will generate 300 million in costs. So, I think you've heard both Bobby and Richard say that we're happy with a lot of this work we've done to set the foundation.

The remaining SG&A work, I think, is to be seen. A lot of it is on some of the demand-generating investments we've made, marketing and technology, where I think Richard and I will really partner on assessing whether we think those are adding the value that we think they need to add or whether there are some refinements we can make there. And that's the next leg of the journey for us to see how we would, if we would, really moderate those in the next coming quarters. So, more to come, but those are the areas, I think consistent with what we've been saying, that we would look at.

Bob Drbul -- Guggenheim Partners -- Analyst

Thank you.

Operator

Our next question comes from Corey Tarlowe with Jefferies. Your line is open.

Corey Tarlowe -- Jefferies -- Analyst

Great. Thanks for taking my questions, and welcome, Richard. You mentioned in your prepared remarks about how you're rethinking about how the brands show up in stores and online. So, just be curious to kind of get your thoughts -- and again, having been on the board since November, your thoughts around the store fleet and how to profitably leverage the store fleet to drive further sales ahead? And then just, Katrina, I just wanted to get your thoughts around, apologies if I missed it, on promotions in the second half of this year.

Richard Dickson -- Chief Executive Officer

Yeah. Thanks, Corey. You know, there's a lot in my opening remarks, and we can double-click on many of them. But in the context of the areas that I see the most opportunities, you know, it's specific to, you know, really working on this distinctive brand purpose that aligns with our customer values and really sets them apart.

You know, as I talk about the brands, you know, and their legacies, I really -- these are brands that matter. And when you have brands that matter, they can be monetized. That being said, you have to make these brands matter more. That has to have great product, great marketing, great execution, and we really need to understand and be obsessed with our customer.

I think that we have elements of it, but where we're going to really work very, very diligently on is creating meaningful differences in the context of our brands and making these brands matter more. When you look at our stores, they need to reflect, if you will, the right narrative in the context of product statements that we believe are heroic, products that we believe will matter to our consumers, the right balance between basics and fashion, and an experience where details really come across to create an experience that consumers will talk about, want to return to, and ultimately find, if you will, the value and quality and product experiences that are required today for brands that win. And that's what you're going to see us work much more diligently on. As transformations go, these things take time.

But we will start to test and roll and really learn essentially what works and what doesn't in a more accelerated way so that we can do more of what works and do less of what doesn't. Lots more to come with lots more examples, and we'll share those as they evolve.

Katrina O'Connell -- Executive Vice President, Chief Financial Officer

Yeah. It's great, Richard. And I think, Corey, to answer your second question, we did see successful expansion of gross margin with lower promotional levels in the second quarter. So, we saw about 200 basis points of margin expansion coming from lower discounting in the second quarter.

Right now, in our outlook, we have basically a flat level of promotional activity in Q3. So, as we talked about, we'll aspire to do better with the lower inventory levels and chase that we have, but we remain cautious on the consumer. And so, we definitely want to make sure that we're offering enough value to the consumer heading into the third quarter. So, we'll see where that lands.

Corey Tarlowe -- Jefferies -- Analyst

Great. Thank you very much.

Operator

Our next question comes from Adrienne Yih with Barclays. Your line is open.

Adrienne Yih -- Barclays -- Analyst

Great. Thank you very much. Richard, this is sort of more of a philosophical question given you've only been there three days, a year and then three days. So, your tenure at Mattel was sort of similar in concept, sort of reinvigorate the core brands, restore growth, and then restore the position sort of as an industry leader.

So, I guess my question is, oftentimes, when you have a company that's been struggling, the creative team and all those assets get very safe, right? So, they become very risk averse. And I'm just wondering, how do you create a culture of greater risk-taking and innovation such that that creativity can kind of come to the forefront?

Richard Dickson -- Chief Executive Officer

Yeah. Adrienne, thank you for that question. It's a great question. There are a lot of parallels with my experience at Mattel and Gap, Inc.'s business across many levels.

You know, and I'm here to architect and orchestrate, ultimately to lead. And the parallel construction of where Mattel was and where Gap is is very familiar. You know, great assets, great talent, a moment where, you know, to some extent, a lot of self-inflicted challenges, some within our control and some ultimately impacting, you know, our business and our industry. And ultimately, you know, a phase that we are going to go through, which is really about unlocking the value of our brands through reigniting a creative culture.

You know, the balance of fundamental and/or fiscal responsibility and operational rigor while you are driving a design-centric and creative culture is the art and science of the leadership that you need to have in this business. It is a very familiar language. It's actually a very familiar model. And ultimately, you've got to be able to take swings that are calculated, test, roll, learn, and scale, and accelerate very, very quickly.

That is a muscle that we will begin to exercise and strengthen with the experience that I bring in the context of that type of leadership. I believe that that's going to add value very, very quickly. This is an organization that is really excited to unlock and reignite, if you will, creativity. And so, I feel incredibly fortunate to be inheriting a business that, from a transformational perspective, has come through, if you will, a very heavy lift and is now delivering, if you will, a fertile ground for a design-led culture, creativity that ultimately will show up for consumers, and the ability for us to make brands that matter matter more.

Adrienne Yih -- Barclays -- Analyst

Thanks. That's super helpful. Katrina, one quick one, sorry. Did you talk about shrink? When do you take your physicals? I think it's midyear, but I may be wrong.

And is there anything that to call out there of note? Thank you very much.

Katrina O'Connell -- Executive Vice President, Chief Financial Officer

Yeah. Thanks, Adrienne. There's nothing notable to call out from us on shrink. We do full counts once a year in the early part of the year, first quarter.

We do partials in the second half of the year. And as of now, our shrink remains below pre-pandemic levels, and there's really nothing to call out. So, shrink is, so far for us, not anything of note.

Adrienne Yih -- Barclays -- Analyst

OK. Thank you very much and best of luck and welcome.

Richard Dickson -- Chief Executive Officer

Thank you.

Operator

Our next question comes from Dana Telsey with Telsey Group. Your line is open.

Dana Telsey -- Telsey Advisory Group -- Analyst

Hi. Good afternoon, everyone, and welcome, Richard. Just following, Richard, in terms of some of the thoughts what you've done in the past, I've read some of the articles about how you put together the thoughts on brand relevance of four points: why do we exist, design-led innovation, culturally relevant, and execute with excellence. How do you look at those initiatives or those topics in comparison to Gap and your initial thoughts on reinventing and rearchitecting the business model in any way? And then, Katrina, just wanted to follow up on, as you think about 2024 and planning, how are you thinking about inventories for the back half of the year and next year? Thank you.

Richard Dickson -- Chief Executive Officer

Thank you, Dana, and thank you for the study of my background and playbook at Mattel. You know, my experience in turning brands around and accelerating performance, it goes beyond the development of a playbook, but really rallying teams to deliver on a plan, ensuring operational rigor, and enabling a culture to execute with excellence. In the context of that methodology, you know, when you look at Gap brands, these are beloved brands. They have a real connection with consumers, and we need to reignite that connection.

You know, I'm passionate about motivating teams to uncover what made a brand or a company iconic and special in the first place and then working together to reinvigorate them to new relevance. So, the familiarities in the context of the work and legacy brands' revitalization methodologies are familiar and similar. That being said, the playbook that we will reveal that will be the strength and the consideration set to reignite The Gap portfolio will be one that we collectively work on as a team as I listen, learn, spend time with our stores, our headquarters, DCs, partners and really start to understand ultimately what will be the playbook that we'll deliver ultimately to our consumers, our people, and our shareholders. And we'll be back shortly to be able to share all of that.

Katrina O'Connell -- Executive Vice President, Chief Financial Officer

And then, Dana, on inventory, we do expect that third quarter ending inventory will be very similar to the first half trends. And overall, more to come as we head into next year, but we expect to be running more and more on leaner inventory, with receipts left opened so that we can be more responsive to consumer demands closer in. And a lot of the transformational activity that we're working on is not only just reinstating the responsive levers that we've had, but working closer with our vendor base to make sure that we have the right materials, the right logic with our vendors to be closer to the consumers. So, all of that helps us to have leaner inventories and be more dynamic.

So, more to come on what those levels are going forward.

Dana Telsey -- Telsey Advisory Group -- Analyst

Thank you.

Operator

Our last question comes from the line of Brooke Roach with Goldman Sachs. Your line is open.

Brooke Roach -- Goldman Sachs -- Analyst

Good afternoon and thank you for taking our question, and welcome, Richard. I wanted to follow up on Old Navy. Can you elaborate on the competitive backdrop that you're seeing in the business today, particularly as Old Navy competes for that value-oriented customer who has options both online and with other discounters? And are you seeing any benefits from a trade-down customer in your stores?

Katrina O'Connell -- Executive Vice President, Chief Financial Officer

Yeah. Brooke, I mean, what we're seeing is that some of the brands that are really winning with our consumer are TJ Maxx, Amazon, Shein. We're definitely seeing those businesses gaining share and those compete with our customer. We're also seeing strong brands like Nike and Lulu and Adidas win, which tells us that great brands win in any economic environment.

Old Navy has the benefit of being the No. 2 brand behind Nike, and so it is a big player in the branded space, as well as being a retailer. So, you know, I'm thrilled to have Richard on board with his experience in creating relevant brands. And that brand already has such a strong positioning.

I think we have a lot to do there to keep winning in that space. So, more to come there, but we're glad with our positioning, for sure.

Brooke Roach -- Goldman Sachs -- Analyst

Thanks, Katrina. [Inaudible]

Katrina O'Connell -- Executive Vice President, Chief Financial Officer

On trade-down benefit, we're not currently seeing any trade-down benefit. That said, we're certainly positioned to add value to any consumer as we move forward since, you know, our goal is to have great fashion at a great value. So -- but we're not seeing that yet.

Brooke Roach -- Goldman Sachs -- Analyst

Thanks, Katrina. If I could just follow up on one other topic. We've heard a number of companies this week address credit and card portfolios amid some of the macro concerns that we're seeing in the environment broadly. Can you provide a brief update on how you're planning your credit business and what might be planned in your outlook for the rest of the year? Thank you.

Katrina O'Connell -- Executive Vice President, Chief Financial Officer

Yeah. It's a good question, Brooke. And certainly, we're watching that, too. So, any trends in credit card income that we see from industry reports or see within our own business are currently reflected in the outlook we provided today.

We do see same as the industry reports, loss rates increasing from the recent lows in '21 and '22. However, ours are not back to pre-pandemic levels yet. And we're working with our credit card provider to adjust our underwriting strategies to make sure we're mitigating risk of higher delinquencies while still providing our customers with flexibility. So, we're actively monitoring the consumer environment.

We're watching the impact to credit. And all of the trends on the credit card customer, again, are in the outlook we just provided.

Brooke Roach -- Goldman Sachs -- Analyst

Great. Best of luck and thanks again.

Katrina O'Connell -- Executive Vice President, Chief Financial Officer

Thanks, Brooke.

Operator

Thank you. We've reached the end of the question-and-answer session, and I'll now turn the call over to Richard Dickson for closing remarks.

Richard Dickson -- Chief Executive Officer

Thank you. I'd like to thank all of you for your time, your interest, and your questions. And I just want to reiterate my belief in Gap, Inc., our people, our brands, and how truly thrilled I am to be the CEO of this extraordinary company. I also just want to thank the people of Gap, Inc.

for this incredibly warm welcome and to thank Bobby, in particular, for his tireless leadership over the past year and for igniting transformative work that I really am eager to pick up and run with. And all of you who joined the call today, I look forward to meeting all of you in the coming weeks and months. And thank you all for joining.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Emily Gacka -- Director, Investor Relations

Bobby Martin -- Chief Executive Officer

Richard Dickson -- Chief Executive Officer

Katrina O'Connell -- Executive Vice President, Chief Financial Officer

Matt Boss -- JPMorgan Chase and Company -- Analyst

Paul Lejuez -- Citi -- Analyst

Alex Straton -- Morgan Stanley -- Analyst

Lorraine Hutchinson -- Bank of America Merrill Lynch -- Analyst

Jonna Kim -- TD Cowen -- Analyst

Bob Drbul -- Guggenheim Partners -- Analyst

Corey Tarlowe -- Jefferies -- Analyst

Adrienne Yih -- Barclays -- Analyst

Dana Telsey -- Telsey Advisory Group -- Analyst

Brooke Roach -- Goldman Sachs -- Analyst

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