Gap Inc (GAP) 2002 Q1 法說會逐字稿

Good afternoon ladies and gentlemen and welcome to Gap Inc., first quarter 2002 conference call. At this time all participants are in a listen only mode. If any one should require assistance during the call please press star zero from your touch-tone phone. The conference call and webcast are being simultaneously recorded on behalf of Gap Inc., and consists of copyrighted material. They may not be re-recorded, re-produced, re-transmitted, re-broadcast, or downloaded without Gap Inc., expressed written permission. Your participation represents your consent to the terms and conditions, which are governed under California law. Your participation on the call also constitutes your consent to having any comments or statements you make here appear on any transcript or broadcast of this call. If you have any questions regarding this policy please contact Gap Inc., investor relations at 650-874-4670. I would now like to introduce your host Heidi Kunz, Executive Vice President and Chief Financial Officer.

Thank you and welcome to the webcast For those of you who are participating in the webcast please turn to slide one. As a reminder, the information made available on this webcast and conference call contains certain forward-looking statements, which reflects Gap Inc.'s current view of future events and financial performance. Wherever used, the words `expect,` `plan,` `anticipate,` `believe,` `may` and similar expressions identify forward-looking statements. Any such forward-looking statements are subject to risks and uncertainties and the company's future results of operations could differ materially from historical results or current expectations. For mode detail on risks please refer to the company's annual report on Form 10-K and/or other filings with the Securities and Exchange Commission.

This afternoon, I will go over first quarter financial results and following my remarks Mickey Drexler, our CEO will talk about the business and then John Lillie, Vice Chairman, Jenny Mind, President of Old Navy, Gary Muto, President of Banana Republic, and Marka Hansen, EVP of GapAdult Merchandising will join us as we open up the call for questions and answers.

Turning to the second slide on sales performance, in the first quarter sales were 2.9 billion dollars representing a decrease of 9 percent versus 2001. Comps declined 17 percent for the quarter following a decrease of 7 percent in 2001 and a decrease of 2 percent in 2000. For the quarter comp store sales for each division were as follows. Gap Domestic negative 20 versus negative 5 last year. Gap International negative 19 versus negative 7 last year. Banana Republic negative 9 versus a negative 8 last year and Old Navy negative 18 versus negative 9 last year. Total sales in Q1 by divisions were, Gap Domestic 1 billion this year versus 1.2 billion last year. Gap International 319 million dollars this year versus 376 last year. Banana Republic 398 million dollars this year versus 410 last year, and Old Navy 1.1 billion dollars this year versus 1.2 billion dollars last year. Sales productivity for the quarter declined to 77 dollars per square foot from 96 dollars in 2001.

I would like to cover our margin performance on slide three. Gross profit in the quarter declined 22 percent to 879 million dollars. This resulted in a reported margin of 30.4 percent down from last year's first quarter margin of 35.4 percent. The decline of five percentage points consists of a 2.6 percentage point drop in product margin primarily as a result of heavier markdown selling and lower markdown margin. The remaining portion of the decline relates to occupancy cost as a percent of sales, which has increased 2.4 percentage points versus last year driven entirely by the loss of sales leverage. While merchandise margins remain below last year's level, the declines were smaller than what we have experienced in the past several quarters and Banana Republic reported a margin improvement year-over-year. Looking at operating expenses on slide four, in the quarter operating expenses as a percent of sales declined 2.4 percentage points from 28.9 percent last year to 26.5 percent this year. In dollar terms, expenses declined by just over a 150 million dollar. Now approximately two-thirds of the decline in operating expenses was a result of either timing or unusual items in both 2001and 2002. The largest items in 2001related to healthcare, IT, excess corporate office space, and the set up of our new shared services center. In 2002, bonus provision is down and 30 million dollars of advertising expenditures have been shifted from Q1 to Q2. The remainder of the operating expense decline is largely attributable to cost reductions from expense management programs established at the end of Q1 2001. More specifically on advertising, expenses in the quarter were 78 million dollars, 31 million dollars less than the 109 million dollars we spend in the first quarter of 2001. Gap and Old Navy drove the variance as they shifted television spend into the second quarter. Advertising in the second quarter is planned to be about a 115 million dollars versus the 70 million spend last year, an increase of 45 million dollars.

Turning to slide five, I would like to cover our earnings for the quarter. Net earnings in the quarter decreased 68 percent to 37 million dollars from a 115 million dollars last year driven by the decline in gross profit partly offset by lower operating expenses. We also experienced an increase in net interest expense from 23 million dollars to 41 million dollar as a result of the recently completed funding program. Diluted EPS for the quarter was 4 cents versus 13 cents last year, a decrease of 69 percent from the prior year. Return on sales for the first quarter declined 2.3 percentage points to 1.3 percent versus 3.6 percent last year.

Now let's look at inventory on slide six. Inventory declined 18 percent from last year to 1.7 billion dollar at quarter end while square footage grew 11 percent. As a result, inventory per square foot was 44 dollars versus 60 dollars last year, down 27 percent from last year. This is the lowest level of inventory per square foot since 1995. As you are aware, we plan to buy our inventory conservatively in the first half in order to manage risk during our turn around and in the weaker economic environment. As we look ahead, our inventory plans are less conservative and hopefully provide a better resale opportunity.

Turning to slide seven, I would like to recap our square footage and capital expenditures in the quarter. In the first quarter of 2002 increased square footage by 11 percent and ended the quarter with 4228 store concepts, which equates to 3125 store locations. Please refer to the press release for a chart outlining quarter ending concept count, location count, and square footage by brands. For the year we continue to expect net square footage growth to be around 3 percent for the full year with about 75 percent of the growth occurring in the first and second quarters. New concept openings remain approximately a 170 to a 190, which equates to a 110 to a 120 locations. Anticipate store closures to be about the same as the 92 concepts we closed in 2001. First quarter total capital expenditures including leased rights were approximately a 107 million dollars, 64 percent below the 293 million dollars spend in 2001. Depreciation and amortization for the quarter was 188 million versus a 196 million dollars last year.

Now I would like to comment a bit on the second quarter. We expect SG&A expense to increase somewhat over prior year to around 900 million dollars despite the fact that unusual items from 2001 are not expected to recur. Most of the increase relates to a projected rise in units sold which raises variable expenses such as store payroll and benefits and variable distribution cost and additional advertising expenditures of 45 million dollars mentioned earlier. Regarding interest, we expect our gross interest expense excluding interest income on cash investments to be approximately 60 million dollars in the second quarter. We ended the first quarter with a cash balance of 2.3 billion dollars, which includes the proceeds from the convertible notes issued in March. Further more, with principal preservation as our overriding objective our cash is invested very conservatively, and therefore earned interest at less than 2 percent annually. Looking at our inventory buys, our plans for the first half remain more conservative than the back half. We believe our product offerings will continue to improve throughout each quarter of the year and we will invest in inventory accordingly. For the second quarter, we expect inventory per square foot to be down about 10 percent from last year, with the second half being down in the low single-digits.

That completes my prepared remarks and at this time I would like to turn the call over to Mickey Drexler.

Thanks Heidi. We continued in the first quarter to focus on the fundamentals of our business and build a sold foundation for improving our performance. Our results haven't yet caught up with our efforts. Our summer assortments at Gap and Banana Republic are performing similar to spring and we are seeing some improvement at Old Navy. However, we are confident that each brand is moving in the right direction and that customers are starting to see better product in our stores. Our assortments are becoming cleaner and more focused and the overall store environments are starting to feel more consistent and brand apporpriate. Product, marketing, and customer service continue to be our priorities and in the leadership side we have also made substantial stride in strengthening our merchandising team at Gap brands. In first quarter, we moved quickly to implement changes and focus on the priorties we outlined in our last conference call, our business is a work in progress. For example, our summer assortments at Gap have a strong color point of view around white, going forward we are working to make sure we bounce our primary color statements with good accent color to create more energy and excitement in the stores. Also across all three brands, out of stocks and franchise items had been an issue. We are fixing that as well. At Gap for example, we are seeing positive turns in our men's and women's businesses as we build inventory in franchise style and key items. White shirts, denim jackets, and our classic of favorite Ts are selling well. The success of these franchise Gap items are small but important indicators that our merchandising strategies are consistent with what our customers are looking for and expect from Gap. As we head into the second half of the year, we are confident that our customers will more clearly see and feel that Gap, Banana Republic, and Old Navy are getting back to what we have always stood for.

Let me update you on each brand. The Gap, on our last conference call we said that a fundamental challenge at Gap was creating a management structure that allows us to move more quickly. We streamlined the organization, created more manageable merchandising jobs, and brought in outside senior merchandising talents were appropriate. For each Gap sub-brand concept we now have focused merchandising teams with strong leadership heading adult, kids, baby, and body. Clearly another challenge at Gap is getting the product right and we've made substantial progress there as well. These created more tightly edited and balanced assortments with an emphasis on making sure we have the right investments in our franchise styles and items such as the boot cut jeans, favorite T, ribbed sweaters, and easy fit khakis. In the third and fourth quarters, we have reduced our product programs at Gap by 25 percent to 30 percent. More focused assortments with deeper investments in key items will communicate a clearer and stronger product point of view to customers. Most important is our denims, khakis, and bottoms business. These always have been Gap's core franchise. Denim, Khakis, and bottoms in the right fits, washes, fabrications, and style drive customer loyalty. For men and women we are focused on continuing to build our authority in denim. We want to be famous for fit and wash. We have new washes in the popular boot fit and standard fits and will introduce the new loose fit in our washes for men. As part of our efforts to continue to build denim authority, we are pleased that Ken has joined us in the new division as Vice President, Creative Director, Denim. Ken who joins us from Cone Mills has extensive knowledge of denim fabrications, trends, and washes. We are committed to re-establishing our credibility of khakis particularly for men. We are introducing fits and styles our customers want in both pleated and flat fron styles and create a khaki's destination store to make shopping easier.

In response to demand from our women customers, we are bringing back stretch in a big way. If fall you will see more of our boot cut stretch and classic trousers. We are also focused on product quality with an emphasis on making sure that key quality attributes are built into each products. We are upgrading raw materials and improving construction and fit. For example, we just completed men's and women's fit clinics throughout the country for jeans and pants. This research will help us improve existing fits and add new fits where appropriate. In tops, we have the broadest assortment of classic and casual woven shirts. Men and women were committed to always being in stock in our franchise Ts, items customers have always expected to find at Gap. also is a big opportunity for us in men's, women's, and kid's. While we made many changes in merchandising, marketing is still a work in progress. We recognize that it will take some time to reconnect with customers through our marketing and that traffic may lag improvements we've made to our product assortments. We believe that creative execution in our summer TV campaign has given a fresh change for the brand and reflecs the evolution of our marketing strategies. Because we haven't been so promotional price wise at Gap, marketing is critical to elevating the brand again. The commercials do that. We are hearing great feedback about the ads. Customers are asking for the white shirts Dennis Hopper is wearing and Kate Beckinsale's long and lean jeans.

Now looking at Old Navy. Jenny and her team has made substantial progress in balancing Old Navy assortments and improving investments in key items and looks. Old Navy is emphasizing the main stay items that built the business and appeal for the entire family. Overall, the summer product has been received somewhat better than the spring. In April for example, the women's stretched capris, jaw string capris, tiny T and rib tank as well as the men's cargo shorts and ringer Ts were strong performers. While our sell through was high, our investments were not big enough in those items.

Going to third and fourth quarters, assortments are more focused and our investments are deeper. Product programs are down 25 to 35 percent compared to last year. Assortments also are more balanced. Old Navy has stepped up it's marketing efforts to more consistently and aggressively communicate the brands products, family, and value messages. The summer TV campaign was launched May 9 and runs through June 6. The campaign features a strong product and value message for the whole family promoting summer shorts in all styles and at prices ranging from 550 to 2450. In addition, Old Navy's third spring circular will be distributed in select markets on May 19. While we are still evaluating initial results, customers clearly are responding to the circular's product mix and value message. We are currently distributing the circular to 18 markets representing 40 percent of Old Navy's sales. We see the circular as an important part of our marketing mix going forward.

At Banana Republic, improved assortments and store environments are strengthening the brand, lifestyle positioning and more effectively serving the brands customer base. Gary and his management team continue to see positive customer response to the brands fixed strategy for men and women. Also in first quarter, Banana Republic generated year-over-year merchandise margin improvements for the first time in two years. In the third and fourth quarters, Banana Republic's product programs are down 20 percent from last year creating a sharper and more brand appropriate point of view. Banana Republic recently introduced a third fit for women, the martin which is performing well as is the gavin for men. Our four branded fits for men, smithfield, emerson, gavin, and dawson have been exceeding plans since their initital introduction in December to a 180 stores. This program was rolled out to all stores in April with newspaper marketing support. Both the men's and women's fit strategies were based on extensive market research and customer feedback. We are very pleased with the response to these initiatives. Category dominance in men's and women's pants is a major focus. Banana Republic is also seeing success in their re-introduction of jewelry to 230 stores.

Operator?

If you do have a question please press star one on your telephone keypad and at anytime throughout the conference your question has been answered please press the pound key to withdraw.

Your first question comes from the line of Carla of JP Morgan

Hi. My question relates to the new stores and the new concepts for this year. I am wondering if you could breakout the, or tell us in general the percentage of stores that are going to be Gap, Old Navy versus Banana Republic?

Hold on a second, we will see if we do have it here.

Ok. And then my second question also is on the same subject. What's the average cost per location?

That's not something that we disclose publicly.

Ok.

What I can say is that we have had over the last few years a certainly aggressive program underway to reduce the cost per square foot for each of our stores and we made some very considerable progress on an annual basis. Ok, in terms of the growth by brand, when we look at square footage growth of about 3 percent. Gap domestic and international are around 2 percent growth. We expect Banana Republic to be about 4 percent growth. Old Navy about 5 percent growth. That's how it will split between the brands.

Ok. Great. Thank you.

Your next question is from Robert Ohmes of Morgan Stanley.

Well, thanks. Just two questions, the first is, maybe it's a little early but can you talk about any kind of new promotional things or advertising things you will be doing in the back half of this year to rebuild the brands as the assortment hopefully is getting better? Can we get, you know, Heidi you gave a little guidance on the second quarter but you did not talk about gross margin at all. I know you are not going to give us a number, but maybe could you walk us through some of the variables or things that you guys are thinking about as you try and get the gross margin to at least stabilize and hopefully improve? Thanks.

I will take the gross margin question first and I think as far as marketing is concerned, you know, we probably wouldn't talk specifically about it, but I think Mickey can make some comments about overall marketing strategy and approach that will be evolving throughout the year. But let me talk a little bit about gross margin dollars. Gross margin percent first. You are quite right, we are a little light on guidance in that area and obviously one of the reasons is that we think that the biggest turn around opportunity in our profitability will be in better regular price selling as the goods that we put in our stores are more appealing to our customers and obviously they buy at regular price. I think, as Mickey alluded too in his remarks, we think actually the stores look better than the comps and and I think what that represents is that we feel there is some risk around how long it takes to get our customers back to restore traffic levels and then also how long it will take for them to feel confident about paying regular price. While we think that progressively over the course of the year our goods deserve a better margin, it could take a little bit longer. What we are looking for is the upside opportunity mostly coming from an improvement in the assortments as Mickey described in his remarks. I think that in the first half of this year when the economy is weak and we are still working on our assortments, wider inventory levels in the store is helping support as well.

And in terms of timing, when we look back at last year because your gross margin started to get hit pretty badly, I think around the second quarter of last year. At what point do you guys look at that and say you know we should start to see stabilization in gross margin on a year-over-year basis.

I think that's a very good point. We saw gross margin declines every quarter of last year but they became very steep in the third and fourth quarters of last year. So certainly if we look at the back half of this year, it would be hard to say that our comparisons aren't starting to get pretty easy. Mickey, you want to make some comments on the marketing?

A couple of things, regarding Gap and I will let Jenny speak or maybe Gary. At Gap, we are very importantly working to elevate the brand again and let people know that Gap is in fact back to what it was used to be in a positive way. I think one of the things we found at Gap is in fact back to what it used to be in a positive way. One of the things we found a Gap in the research and customer feedback and store feedback is that we have certainly turned off a number of our customers over the last year when they couldn't find what they wanted to find. Our first thing is to elevate the brand and get it back where it was. I think the TV campaign this summer with Cameron Crowe and The Coen Brothers and Roman Coppola directing, I think it's to do that. It's a really positive feeling from the brand and the feeling of where we used to be and where we should be moving forward. So we are trying in every way to reconnect with our customers. We are in the process of shooting the fall campaign right now. It completes it's shooting this weekend and you will see a sensibility of Gap that I think we haven't seen final pictures yet. We are very pleased with two things, one the sensibility in the field of pictures and products we are showing and also the kinds of people that are in our ads and I think given the co-operation we get even in the marketplace and the enthusiasm of who wants to be in our ad, I think it's still positive reinforcement for the Gap brand. So we are doing that. We will be starting to work on TV over the course of the next few weeks. We have a shorter lead-time there and in addition to that we are just working to make certain from a marketing point of that, the stories themselves really reflect what the brand is about. As we visit the stores we see the change in product. It actually makes it easier to market it to our customers, we have products they are familiar with, and they want, they ask for and that they see back in the stores again. But we've had a pretty intense rebuilding and elevation challenge of the brand. So we will move forward and be aggressive in terms of how we notify people. Jenny, you want to talk a little bit about that.

Old Navy obviously on marketing is focused on our core strength, which is fun, fashion, and value for the whole family. We just broke out some of our advertising last week. Again, it's a little early to tell. But so far we are pleased and we are really trying to bring back the whole passion and value, a very strong value message. We are really bringing the family back into the brand. That's what is going on and we are definitely stepping up on our marketing going into third quarter. We are starting to work on our back-to-school campaign. But we are not there yet.

Gary?

In Banana Republic, it's same thing like Gap. We are really trying to elevate the brand and have really shifted away from division. It has a much more polish and a more elevated sensibility and also a grown up sensibility. We really do wanna appeal to an older customer. We really believe that we have a new compelling way for them to dress for fall and that's where the emphasis will be. I am also in-store environments in the way we communicate to our customers and are a major initiative for us. We owe it to them to tell really clear and concise way stories in a very very compelling way in our stores.

Operator, is there another question?

Your next question is from Kendra Delaney of Fulcrum Global.

Great. Thank you. I am wondering if you could break down the operating margin by division? I know you don't use that much of a detail, but maybe tell us relative to where the company in total came in?

No. I am afraid we don't disclose it by division. What we did indicate though was that in terms of year-over-year performance we are really quite pleased that Banana Republic was able to deliver a better merchandise margin than prior year, which is the first time they had that positive movement in two years.

Your next question comes from John Morris.

Thanks. I guess my question is this. You had indicated, I think you were lucky to come in at 2 to 3 cents and here you came in a little bit better and obviously that quite a positive. But, I am wondering where the difference came just in the last week? And then, I have got a followup.

I think if you can appreciate, we are a very large company. We had not closed our books at the time we gave guidance last week, the only thing we knew for sure was margin dollars because that we get on a daily basis. But there's an awful lot of money between gross margin dollars and net income and a penny is only 15 million dollars of pre-tax earnings. So, frankly I just think that's just a normal margin of error.

Okay, I have got a question about your initial price points at each brand. How it is changing and how do you feel about them now, where you are going with your initials?

Well, what our objective is to certainly to sell a lot more merchandise at regular prices. That is very very large objective. There is no change in pricing and our positioning in the market. What we are actually doing is pricing goods of what we think of fair market value. In 2001, it is clear that in Gap, we are extraordinarily too promotional and we are trying to buy business, what we are not doing anymore. We are looking to be day in and day out integrity seller at Old Navy strategic promotion, as we will at Gap on Back to School event; Banana Republic is not in that area. One of the things on pricing that we can do is very importantly give customer added benefit, our Gap quality for example, but we are not raising prices. We are giving a lot more emphasis on quality in make of garments. We mentioned in the past that were so large, didn't allow us to meet the kind of quality we would like to meet. Major objective is much more regular price with focused assortments, that automatically usually happens. This is not broken as quickly as you . The more assortments to more styles are less narrow, assortless investment, means more markdowns. So, we are very very about. It is a major objective throughout the three brands.

Your next question comes from Dorothy Lakner.

Good afternoon everyone. Could you give us a little bit of color on the Kids and Baby businesses within Gap brand and then also talk about International and whether or not you are seeing the same item successes in merchandises you are seeing so far in the US?

Regarding Kids and Bbaby, the Baby business has actually been quite good. We are quite please with and I think it reflects itself in the way the stores, you know lot of what we look at is essentially same as customers look at but our Baby business, we have been quite please with at Gap. The Girls' business is kind of the adult business. It is not necessarily reflecting itself in the way we like to see it. I look at the Girls' assortment and we do think somewhat the same as Womens' in term of what is lacking in it in the proper product environment. So, we are working on that. Boys' assortments are coming along more. So, they are looking more boy-like, more consistent on colors. So Baby has been very positive, Girls is more of a challenge and Boys is coming along well. I think as you look at Girls, going forward, it very much reflected itself as Gap has always in the style and taste and quality of the assortment. So, it is in the same progress as adult. Internationally, we pretty much got the same response as we do domestically, the world is a kind of a small place and lot of and the results are pretty much consistent with the US's result.

One of the differences that we talked about is the investment in more marketplace, in particular, in Japan - Japan specific dress and we introduced that not long ago and that has been quite successful. But, otherwise, products by product, the winners and losers tend to be the same as the US.

The next question comes from Richard Jaffe of UBS Warburg.

Thanks very much. A question for Mickey. The effort of streamline management at the Gap division and to speed up the process, I am assuming that strategy with Fast Track; I was wondering how that has come along? How it is working and how it is seeing manifestations of its performance?

Did you say Fast Track from the sourcing point of view Richard or just how it is just smaller organization?

I guess both. I assume that small organization assume, you know, the management team is more up in making decisions closer to consumer need and Fast Track is a .

The organizational structure now allows for much stronger ownership with smaller pieces of the business. So, Marker CEO, who is joining us next week, runs the Kids business. He is an experienced merchandiser who is just joining us with a couple of experienced merchandise of in-house. reports to me as runs Baby and . That in itself breaks down the world into much smaller pieces, with International of course, separated. What I am seeing at Gap is much closer interaction between us, not necessarily like the old days, but when we built the business, it was quick decisions, making decisions at the time they have to be made. Speed is of the and I think we talked in the last conference call to how our outsourcing, in fact, we have shortened the lead times to a degree in certain areas of decision making. It also enables us on ownership to be at our resources. This is our factory areas that in fact, impact the assortment and the look of the goods. So, Richard, I think what is happening is with strong ownership we are getting speedier reaction in every division and really strategically in the corporation, we have all talked about ownership by division moving forward quickly. It has got to be competitive and got to be fast.

Your next question is from Jennifer Black of Wells Fargo Securities.

Good afternoon. I wondered if you could talk about what kind of comps do you need to get positive leverage on buying and occupancy?

You mean, to leverage our occupancy expense rent to occupancy and depreciation?

The way we look at it is, one positive comp point we probably leverage about half a point on

Okay. And then secondly, this is my view for Mickey. I know that you have been very focused on your fit and I wondered how changed your fit and if you could just talk a little bit about that?

Ok, I am going to let the team heads talk a little about fit SPECS . I know that if you have been trying on our , I hope you are finding some improvement. Therefor, we have identified to fit clinics nationally and visiting with our stores. The merchant team, they should of course on the fit clinics and I will let Jenny, Gary or Marka take that with a bit more specific answers that me.

With regards to Gap brand, we have done a lot of work in the field with customers on our fit. One thing I do want to emphasize is that our fit as been consistent. Now, you might not like a low jeans but our fits have been consistent with Gap brand for eight years. So, we do not have inconsistent fits. What we are trying to do is expand the fits to be more democratic and that means that there is something for someone on 17, there is something for somebody on 20 and 30 and there is something for someone who is at 40. So, just across all of our product offering contents to make sure that we have a wide range of appeals. So, there is something for everyone in our fits and I think that is where the change is, it is not too much, but we have changed this fact that .

Then it is first in really branding three different pant fits that hopefully appeals to three body types and in talking to customers in doing the research, it is working. So, I think, that really is the key message there, similar to market that there is a pant fit for every body types.

And you know Old Navy, we have got an offset and we are bringing fits in and we will all be inside pretty much in July for fall and it is really trying to appeal to a broader customer base and the ones that we have brought in have been terrific, making mention the . There is a broader customer in that and we see it extremely well. Where Marka said in Gap, it has been much more consistent in fit and only that we haven't that as consistent as we like it to be and we really focus a lot of work on that and I think you will see it improving going forward.

Your next question comes from Joe Teklits of Wachovia Securities.

Hi, thanks everybody. I am trying to simplify the Back To School strategy in my mind and I don't know if it is possible but when you are talking about reduced product programs for each of the brands concepts, 25 is the percent and are you bringing inventory down that much. I think that also implies to your commitments to reach individual style. I am curious if that then creates markdown liabilities if those styles are wrong. I am trying to see where the risk to this strategy is and I am also trying to compare it to something that a few seasons ago, when there was talk about basics and trying to push markdowns out later in the season etc. If you can reconcile those two initiatives.

Regarding the decline in assortments, we were just much to much assorted, so over-assorted last year that we made it very difficult for a customer in our brands to come in and see it. I believe it is what this brand is all about and I think any great brand has a clarity about it that does not have to be explained to customers to a large degree. We use to, before the last year, what our stock in trade has always been in all three brands is having a strong point of view in the business, investing in that point of view, having a key items focused in that point of view, and making certain that the point of view is not in goods to the left or much to the right of what our customers expect. There is sweet spot in each of our brands that we have strongly identified, that we used to have every right now, that we are looking at. And, where we are doing that is actually working. Now, right now we are not at this level of investments we have got to be. As we work towards that at the end of this quarter and third quarter, we are going to be much more comfortable in those investments. The other thing in terms of markdowns, what caused plenty on markdowns is not the first. It is the second and third and the fourth that leads to major margin deterioration in our business. And when you are investing aggressively in a strong message and the message is that we are strongly invested in our in each of our brands that our customers expect - whether it is a bhurka jeans, rib cotton sweaters, back to performance may be, you know the standard fit jeans we have in Mens Gap. Throughout the brands our investments are in those items that our customers expect and they are very comfortable with. For example, if you markdown a big buy that you haven't too many on something that you sell through with 60 or 50 percent. The markdowns usually grow with one markdown. In bag goods and novelty goods and made good, they can take three or four and the margins on those herd up profitability dramatically. So, in a sense, this is the best way we know to make money is there for strong conviction and of course we go in on every item we invest now, I would say before we use to do but still this year was one of those years. We evaluate the upside and the downside and we know we have an exist strategy on every large investments and are very comfortable with that.

Your next question is from Dana Telsey of Bear Stearns.

Good afternoon everyone. Mickey, can you talk a little about Mens and Womens' businesses. What are you seeing there in each of the divisions, bottoms versus top and are you comfortable with the results of the third and fourth quarter? And then Heidi, can you talk a little bit about advertising expense. You shifted some dollars into the second quarter from the first. What should we see for the balance of the year?

You want to have Heidi answer first.

I can take the advertising one. Obviously, we gave you some pretty specific guidance as to what to expect in the first half and our plans are pretty firm. So, we would expect to come in pretty close to those numbers for 2Q. As far the back half of the year is concerned, we are still evaluating specifically what we would do and so we probably are going to spend more money than we had indicated the last time. So, you know, as we are looking at it now, the year as a whole, advertising could be up by as much as 10 or 15 percent in dollar terms year-over-year. But that is not yet a firm number because the back half is just firm yet. But, we think the increase in investment might be even little bit larger in the back half than what you are seeing now in front half.

With regard, Dana, it is Marka answering on the Gap brand and what we see, I am not quite sure what the answer is to the balance between tops and bottoms. So, what I can tell you is as we continue to get closer to returning to Gap iconic looks. Things are working very specifically - the jean jacket, the favorite T, the classic T, carpenter jeans, active looks in Womens are outstanding white shirts. We are extremely pleased about it as we get into the back half of the year where we positioned ourselves. It is to get closer to what we . Each of those looks as we regain authority on those, is working extremely well. So, specifically, that is where we think we want to continue to focus on our Gap iconic looks and that is we are doing for fall.

Your next question is from Maura Byrne at Salamon Smith Barney.

Good afternoon. A question. As the business has started to turn, is there more margin opportunity at Gap brand or Old Navy? And a followup question on product program. When was the last time the actual product program was we could say this is the comparable level of SKU? Thank you.

I will take the margin opportunity first. I think the best way to answer that is to say there is ample opportunities in each one of our brands for margin upside. It is really considerable in all three brands.

What I mean is that is you are asking about program. The last time program is probably 1999 and 2000 for us in Navy.

All three brands. Might be we have reused that as a base year of work force.

Last year was over the course of the year, we started to get very overassorted especially in the back half.

Which led to low margin, less markdowns.

Your next question comes from Todd Slater of Lazard Freres.

Good evening. I was wondering if could just talk about how the decline in inventory spread between the three divisions? Secondly, in minimizing some of the out-of-stock problems that have been occurring. I just wanted to know if the deeper investment strategy, is that part of the fix and how do you avoid getting too narrow and too deep? And then my third question is with respect to Old Navy, in the past you talked about some strategy to strengthen the store or do some things. I am wondering, if there is anything you could do to fix the real estate issue other than simply closing stores or attrition if you have come more recent conclusions on Old Navy real estate. Thanks.

Why don't I take the inventory one first. If you look at the inventory per square foot decline, which I assume was the nature of your question, it was probably heavier at Gap Brands than at the other two. And when we look at inventory per square foot historically, I would say that Gap Brands has to reach back a few more years than the others to find themselves at this level of inventory per square foot. But, I got to tell you that all three were down quite materially.

At Old Navy, we are testing about 60 stores, downsizing and we really has not been in a full season yet. So, we are going to make a decision in June. But we are talking of 60 stores, and we are not talking about any of our closing store. In fact, we are really looking at just shrinking . We don't have to look at it probably some time in June.

And in terms of the other question relates to all brands, could we be too narrow and deep. Last year was an extraordinary event in terms of assortments and this is just a balance that are moving back to where we have been on a comfortable level. We lay out our stores by style and by category before we buy anything and we certainly have been very religious about that, now for the third and the fourth quarter. We are very comfortable with the amount of assortment. We are very comfortable with the focus of Gap's Brand there.

Your next question comes from Mark Friedman at Merril Lynch.

Thank you, good afternoon everybody. Mickey, the summer response has not yet seen the traffic pop. How do you clear through these goods without hurting your focus to regain the full price-selling atmosphere? Or with the inventory so lean, do you expect to see an improved markdown margin even if the true full price lags? Also, are you seeing anything on the sell through regionally different given the different weather trends we have experienced and summer, coming to the stores?

Does this relate to all three brands?

In Gap in terms of the summer campaign, we had again significant traffic last year driven by markdowns and quite low average retails. The summer campaign is generating a good buzz, as I mentioned, specifically for white shirts and long and lean jeans. And I think it is going to take a tumulus effort in Gap to get the customer back and familiar with that we are back again and I think it is a bit too early to measure. So, we will continue with the TV campaign, we are working at a print campaign network. We are pleased in terms of its direction. I think, the question for us is when will we start to recognize, that we are doing everything we need to do - follow the get the windows looking better and looking more right, getting the in-stores right. And, as I visit our stores and everyone's stores, I think the most important message we can give to our customers is to have stores that look good and actually what we are working on doing is the highest priority. But, you know, we are up against the Gap particularly a lot and lot of promotional low price business, tells customers that we're back. Print campaign in works. Also working on making stores look good.

For us summer campaign is slightly at earlier. I think it is too early to count. But in short, for the entire family, we think it is very appropriate and that is if for summer. It just started, actually the weather right now. So, we are expecting good things from that.

I don't think we would want to comment on just ten days. We can certainly talk about that on the sales call for the month. Obviously, you know, last month we saw very very significant regional differences, all weather driven.

Your next question comes from Stephen of Morgan Stanley.

Good afternoon. I have a couple of questions. One was in aggregate, what are the goals here in terms of turns of the inventory on an annual basis? Do you have a number in mind?

No, I think it is very brand specific and very product specific. We would say though that if you look at our inventory turnover rate of the company, we don't perform any better than may be middle of the pack when you look at our peer group. So, we think there are opportunity there in a number of IT initiatives and sourcing initiatives we have under way should enable us to improve our inventory turnover, many of those investments that don't come on line for at least a year and a half. So, I would say that those are the kinds of things that can help the productivity of our turns, obviously, in the near term, the more white we are the more on we are in terms of products, the faster it will turn in the store.

Your next question comes from Dan of Goldman Sachs.

Hi, I was wondering if you could comment some more on, you said that the summer is certainly forward and similar to spring. I was wondering if you could provide a little more feedback on that in terms of specific products that are working and not working.

With regard to Gap, We are actually very pleased with our summer selling on fashion goods in the Men's division. It has seen some very strong performance out of summer fashion. We are little bit more constraint with the Women's fashion. We have had some bright spots there. Like Jenny, we are doing very well pants and we did a whole white shop in the stores, we have had some very strong performance on side stretch to please in Women - as I said jean jacket, white shirts and women's polo shirt has been outstanding. So, there has been across each category, in general, we had some really really strong performers in summer. But, I would say overall, I am much more pleased with what I have seen with the Men's turnarounds for summer than it had been for Women.

In Old Navy, overall we are very pleased to for sure, summer is performing better than spring. I think that I mentioned throughout spring actually has been doing extremely well and so is our T-shirts and in Women. In Men's our Cargo pant, Cargo shirts I am very pleased with the progress. Our Baby business is extremely good. It is across everything pretty much in Baby - kid's short and T-shirt.

In Banana Republic anything in Women's has performed very very well, especially Women's in the other two brands. Any pants in Women's have been really very very strong. White shirts in Women have been very very strong. In Men's, with relaunch or Chino, we are very excited about that as well as novelty pattern woven shirt in Men's that are doing very very well.

Your next question comes from Barbara Wykoff of Buckingham Research.

Thank you, can you talk about what percentage of pant assortment is in the key silhouette at this point and what do you expect it to be for fall? And then also a sort of related to that, can you talk about the result of the extended size of the 16 to 18 in Old Navy and Banana and Gap on the Internet?

The pant assort relative to fall is really a work in progress. I think you are asking what percentage is now versus what it will look like for the quarter?

Yes.

Each of the brands is well .

In Old Navy, in Women's last year we had a lot of apparels sitting on ultra low and low rates. This year it is really much much more even on the rate versus just below the rate. I would say about 50/50. A good amount of pants are for younger customers and so low rates and ultra low rates are still proceeding extremely well. And for the extensive guidance, all our basic franchise items comes, especially in pant in Women, up to size 20 and it will extend even further in our fashions pants in our direct business. In Men's our basic franchise item extends up to 44 and more so on line with our business. So, we are very pleased with our extended type business overall.

and that is basically how we look into strategy going forward. Obviously two of those are better than the other on and not really can we maximize that in inventory investments. As far the extended size 16 on line, we are happy with the results, we are not committed to rolling that out to the stores yet. We will be able to get to opportunity, maximize our size scales within the store before we add additional size.

Your next question comes from Richard Baus of CSFB.

Good afternoon everybody. I have got a couple of questions. One is Mickey reduction on product programs of 25 to 30 percent. What are the major programs in each of the business that you have eliminated?

Fair, good, markdowns. Fashions that was very trendy. Things that didn't meet the specific target of each brand. It really wasn't difficult to do. As you evaluate the profit item by item, it was clear we kind of, had open a box. What could end up on the markdown. Well, we had our store managers visiting with us this part of the strategy and we tried to eliminate all the identifiable markdowns in the company and that is the possible thing in the apparel business. But, it really was not difficult. We didn't eliminate anything in our mind that our customer expects to find from us. Since we believe in moving forward, we still at the end of the day have to give what the expected and what the incoming and ongoing of items in the business. So, we are not concerned with the elimination. I think it leads to all the benefits that we talked about in this call that is absorbing more focus less markdown problems etc. I much rather be in size and that essentially is what we are doing throughout each of the business by item. We are we rather cut back the so we are not walking customer to things they want to buy.

Your next question comes from Emme Kozloff of Sanford C. Bernstein.

Hi, everybody. I have two questions. The first one is about store operations. We have recently done a number of store visits throughout the country and found a lot of merchandising with very good product etc, particularly in lines. I wanted to find out, is this due to labor savings or is it just poor store level execution. We have also heard that there has been a lot of turnover in the store operations ranks over the past 12 to 18 months. I wanted to get a perspective on that. My second question is about denim, last year, particularly during Back To School, you guys made a major commitment to denim and consulted all the other specialty players and it was undoubtedly fashion denim. Now, everyone including yourselves is returning to a classic look but also emphasizing denim. So, what makes you believe that you are going to be more successful this time around or what would make it different this year?

What are we talking about store etc. Any brand in particular you mentioned on that question. Oh I see. Well, I am not sure what brand we are talking about specifically. But, I assume it is Gap. I don't disagree with what you said. We are rolling out brand standards throughout the Gap division. Part of the problem with close has been some of the party issues we are still living with. The fact that our displayed in the stores have not been what they should have been and store changes led by COO with Gap are making a very conservative effort to make certain that every store in America understands the standards in which we operate on and the presentation and the creative presentation of each of the stores. So, I think you will start to see improvements there. I think it maybe in demand of our category. I am not sure what you are referring to specifically.

On the second question you had about why we think denim is something we should be investing in for the third quarter and why we think we can win, I think for the Gap brand there is no question of fit. And, it is having the right fit, the right fabric and the right quality for a broad group. So, if you take our bhurka for example, that has a broad appeal and we put that, so we have doubled the ownership that we have in the variety of washes. We have added things like stretch; we have added other fabrics like corduroy. So we know we are jeans fit more people and we think we have the right investments, as I said earlier customer, for a broad middle customer, for all customers. And that is what can win at the fit game because we are really good at fit and the assortment.

And in terms of store turnover, I am not familiar with that as an issue.

Your next question comes from Charles at .

Hi, guys. It sounds like you have done a good job and this sounds great. I am just curious if you could give some idea of what would be reasonable to expect for comps or for earnings or if you could may be just talk to street numbers I can quote on for the year.

For sometime, we have not been giving specific comps or earnings guidance and I don't think you should expect that from us until we have some momentum behind us in our business. So, I am afraid we won't give that to you today. I would say though, I hope at least the message that you heard from Mickey is that at least from our standpoint, we think our product offerings are going to be better each quarter this year. And certainly you can just look at the numbers for last year and realize we are up against some pretty weak numbers in back half. We will be investing a little bit more boldly in the back half of this year than the front half or less cautiously, let us say. So we are trying to set ourselves up for gradual performance improvement and I think that is as specific as we like to be at this time.

Operator this will be our last question.

Okay, and that question will be from Rick Kaplan of Legacy Asset Management.

Hi, just a clarification if I could, Heidi, I think you said when you were giving guidance for second quarter. Did you say interest expense were balloon to 60 million?

Yes.

Okay.

That is gross interest expense; not including the interest earned on our cash balances.

Right. Okay thank you.

Okay, on behalf of the management team, I would just like to thank all of you for participating today and as always the investor relation team is available for followup question. So, thank you and good-bye.