Gap Earnings Call Insights: Seamless Inventory Initiative and Operating Margin Opportunities

Gap (NYSE:GPS) recently reported its first quarter earnings and discussed the following topics in its earnings conference call.

Seamless Inventory Initiative

John Morris – BMO: Congratulations, everybody on a great start to the year. I guess and maybe Glenn you talked, really effectively you and your team, when we had the Investor Day about the seamless inventory initiative, which you touched on this morning in your prepared remarks. It sounds like its rolling foreword maybe a little bit faster and into place than some of us might expect, which is great. Wondering, if you can talk a little bit more about the performance contribution potential you might see coming from that? I know it’s hard to predict, but maybe it’s helpful to think about it relative to some of the global competitors who have some of those initiatives already in place that you would probably know about?

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Glenn K. Murphy – Chairman and CEO: John I’d say there was really two parts that we talked about in April. So, I will just from a terminology perspective, the seamless inventory and the idea behind that – that’s going to take a little bit longer. That’s more of a midterm opportunity for the Company. The idea behind seamless inventory is right now as a Company and this is true of almost every single apparel company with likely the exception of Inditex. That we have inventory, that is either in a country and then what is inside of a country like Japan than its inside of a distribution center that’s online, inside of a distribution center that could be for stores and that’s inside of our 150 stores in Japan. So the idea behind this is how do we – and with the systems we are putting in place now and some changes in process, how do we make sure that our inventory becomes seamless when it leaves a factory for the vendor that a 100,000 unit PO that was agreed to weeks before that, just before it leaves and goes to the most appropriate country where it makes the most sense. Where we can maximize our sales and maximize our gross margin dollars because its matching supply with demand and then when it gets inside of the country, again how do we make it seamless between – and that’s assuming it’s at a single distribution center and that would make a big difference for us. Then when I guess inside of that distribution center how do we make sure it’s seamless between the online channel and the stores. So that’s a project that we have already done some work on. We are building the phase and I think that’s going to be more of a 2014 and beyond opportunity. The other part that could be, I guess be viewed as seamless inventory is what we are calling a more responsive supply chain. That is really, us as a business. This is something that in hindsight I probably should’ve pushed a little more aggressively inside the Company but we have told people in the past that our supply chain needs – in order to become more responsive it needs to be built on having much work fabric platformed inside of all of our mill relationships. Once you have fabric platform, then you could be a lot quicker on basic inventory, seasonal basic inventory to get a read and respond, and we’ve done some of this and there’s some of that going on the Company today, but I guess, if I was to characterize it, if we consider to be world class we are probably in the second inning – from a standing start we’re probably in the second inning right now of actually getting to a more responsive supply chain. Some of that will happen in 2013, a little bit, but again, most of the benefit from changing how we operate – changing the brand’s operating model to be much more in a responsive supply chain will happen in 2014.

John Morris – BMO: Glenn, are those potentially contributive in the hundreds of basis points over time, just order magnitude benefit?

Glenn K. Murphy – Chairman and CEO: It’s tough to quantify. Always said John before is that the people with the highest operating margin in our industry are in the high teens and we are in the, call it for argument’s sake the mid-teens and some of that difference, not all of it, some of that difference is that they have embraced a more seamless inventory management operating model and their business was built on a responsive supply chain. So, we’re different businesses. Then, the leader is when it comes to operating margin, but I think there’s definitely some application for us that we’re – some of it’s in place now, but a lot more to come, but it certainly doesn’t explain the whole delta of 400, 500 basis point difference between ourselves and the leading Company in our sector, but I think there’s some differentness. Some of that could be explained through the fact that we haven’t embraced ourselves, those two opportunities. So, more to come and we’ll see if we can get it in place for 2014, but there’s certainly value attached to it. I just can’t quantify for you today.

Operating Margin Opportunities

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Kimberly Greenberger – Morgan Stanley: I’ll add my congratulations as well to a really terrific quarter. Glenn when you think about the operating margin opportunity from some of these strategic goals, maybe you could just rank order them in terms of, where you’re seeing the greatest profit opportunity upside might be. Is it the seamless inventory or the more responsive supply chain? Over the next sort of year or two, do you think you’ve got an opportunity to further lower your average unit cost or are you sort of seeing some stabilization there with perhaps some wage pressure creep into either late 2013 or 2014 costs?

Glenn K. Murphy – Chairman and CEO: I guess its two parts. If I focus exclusively on average unit cost, the opportunity clearly for us is to use less fabrics in the business and have people – our vendors are becoming more and more sophisticated and they are spending money on equipment and they are able to take a fabric now and do multiple things through washing and then treating it that they couldn’t have done five years ago. So, I think that having fewer fabrics inside each one of our brands and committing for a longer period of time, let’s call it for a year or more to that fabric, I think still gives our designers and our merchants, huge flexibility to do the right thing on product. We’re not going to sacrifice anything for efficiency to not give them the ability to do the right products in all the categories I talked about earlier. But I think it’s clear to us now that we can reduce that, give our sourcing team an ability to go work with the mills, by having less fabrics and going for longer commitments. So, I think there is value in that to be unlocked inside the Company. Whether that value can offset wage pressures and everything else that’s going on in everybody’s supply chain, that’s to be determined. I’m just happy that, as I stated probably five years ago, I am just happy we still have lots of opportunities to improve the business from – either from a cost perspective or from an earnings perspective. Because what I am identifying here from an AUC is something that we do today. We just don’t do it as much as we should. The Company has always had lots of priorities. The great thing about Gap Inc., is we are rich with opportunities and this is just one we talked about before that I believe we can do a lot more with this and our vendors agree. I know this. I was with all of them. I spent 10 days in March in Korea and China and India. So I was speaking to them about how much more we can do, explained to them our plan, trying to quantify the value of that. So our team is working aggressively to get that one component done. On your first question, it’s tough to rank them Kimberly. What I’d say there is three opportunities we spoke about at our Investor Meeting in April. I apologize simply the (indiscernible) wasn’t there. But we talked about the omnichannel opportunity which I think there is value unlocking it for sure and we are pretty far ahead and there is lots of components to the omnichannel that should generate real value. The value looking for is in the sales line and in the market share opportunity. Then as the two that I just talked to John. So, ranking them is difficult. I think all three have contribution and value to be unlocked between the three of them. The only thing I would add to it is not much difference between the three. So the reason that one is worth a lot and the other one is just a marketing term that we are using, because we want to look like we have opportunities. All three have opportunities and value to be unlocked. I’d just say they’re all equal for now until we actually get them in place and get a read from our customers and see what it can generate in terms of earnings – incremental earnings for the Company. So we are fortunate to have all three of those opportunities available to us.