蓋璞 (GPS) 2002 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen.

And welcome to GAP Incorporated second quarter conference call.

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I would now like to introduce the host, Heidi Kunz Executive Vice President and Chief Financial Officer.

You may begin your conference.

Welcome and thank you for being on the web cast and call.

Those of you participating in the webcast please turn to slide one.

As a reminder, the information made available contains certain forward-looking statements which reflect 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.

They're subject to risks and uncertainties and the company's future results of operation could differ materially from historical results or current expectations.

For more detail, refer to the annual report on form 10K, and the filings with the Securities and Exchange Commission.

I will go over second quarter financial results and following my remarks Mickey Drexler, our CEO, Gary Muto, newly appointed President of GAP, and Jenny Ming, President of Old Navy, will talk about the business.

And then John Lillie, Vice Chairman, Maureen Chiquet, newly appointed President of Banana Republic, and Marka Hansen, Executive V.P. of GAP Adult Merchandising, will join us as we open up the call for Q & A.

For this call, I want to point out that Mickey and I are working out of our New York offices, and the rest of the team is in San Francisco.

So we'll do our best to make this a smooth call.

The second slide on sales performance, in the second quarter, sales were $3.3 billion, representing an increase of 1% versus 2001.

On a year to date basis, sales totalled $6.2 billion representing a decrease of 4% versus last year.

Comps declined 7% for the quarter following a decrease of 9% in 2001 and year-to-date comp store sales were down 12% versus a decrease of 8% in 2001.

Please refer to the press release for divisional sales results and comparable store growth rates.

Sales productivity declined to $86 per square foot from $94 in 2001.

I'd like to cover a margin performance on slide three.

Gross profit in the quarter increased 5% to $1.1 billion.

This resulted in a reported margin of 33.4%, up from last year's second quarter margin of 32.1% The increase of 1.3 percentage points consists of a 2.1 percentage point increase in product margin by better is and markdown margins and an increase in regular price selling.

This increase in margin was partially offset by an increase in occupancy cost as a percent of sales of .8 percentage points versus last year.

Merchandise margins improved over last years levels at all divisions except International.

Old Navy and Banana Republic showed the greatest improvement.

Gross profit for the year-to-date declined 1.7% to $2 billion.

This resulted in a reported margin of 32%, down from last year's margin of 33.7%.

Looking at operating expenses on slide four, in the quarter operating expenses as a percent to sales increased 1.3 percentage point from 26.9% last year to 28.2% this year.

In dollar terms, expenses increased by approximately $49 million or 6%.

For the quarter, advertising expenditures were $117 million, up $47 million to prior year, due to a timing shift from the first quarter as well as incremental advertising in Old Navy.

We also saw higher store payroll and benefits expense and bonus accrual.

These increases were partly offset by expense savings due to last year's work force reductions and the absence of last years one time charge related to those actions.

On a year-to-date basis operating expenses as a percent to sales decreased .5 percentage points, from 27.9% last year to 27.4% this year.

Turning to slide five, I'd like to walk down to net earnings.

For the quarter, operating income was $169 million.

This is flat to last year, as the increase in gross profit was off set by higher operating expenses.

Net interest expense increased to $57 million from $27 million.

As a result of the recently completed funding program.

At present, we're holding the 49% tax rate which results in net earnings of $57 million versus $90 million last year.

Diluted EPS was 6 cents, down from 10 cents last year.

When looking at the first six months, while performance improved in the second quarter, year-to-date operating income of $281 million was down $92 million from last year reflecting relatively weaker first quarter results.

Net interest expense in the first half was $98 million versus $50 million last year, and net earnings was $94 million versus 205 last year with EPS at 11 cents versus 23 cents last year.

Next let's look at inventory on slide 6.

Inventory declined 14% from last year to $1.9 billion at quarter end, while square footage grew 8.7%.

As a result, inventory per square foot was $48 versus $61 last year, down 21%.

Inventories were somewhat lower than anticipated due to the timing of shipments at the end of the quarter.

Turning to slide seven, I'd like to recap the square footage at capital expenditures.

In the second quarter of 2002, we increased square footage by 8.7% versus the second quarter last year and ended the quarter with 4,261 store concepts, which equates to 3,139 store locations.

Please refer to the press release for a chart outlining quarter ending concept count, location count, and square footage by brand.

For the year, we continue to expect total net square footage growth to be around 3%.

Our current outlook for capital expenditures for 2002 is $360 million, down from a previous guidance of $400 million.

We have seen significant decrease in new and existing store capital, mostly due to our efforts to reduce the development cost per square foot.

We have reallocated those savings to IT to accelerate the implementation of initiatives.

As a result, new store capital is estimated to be about $100 million and remodels about $50 million.

IT will spend about $60 million, and the remainder will be split between distribution centers and headquarters.

Also we anticipate full year depreciation and ammoritization to come in the low $800 million range.

Second quarter year-to-date total capital expenditures, including lease rights were approximately $163 million, 70% below the $547 million spent in 2001.

Depreciation and amortization for the first half of the year was $389 million versus $382 million last year.

Turning to the last slide, I'd now like to comment on the current business and full year guidance.

So far this month, we have not seen an improvement in the weak traffic trends that we and other retailers began seeing in the second half of July.

The retail environment also continues to be promotional.

As a result, our beginning of month sales are short of projections, but each brand is responding aggressively in the second half of the month with strategic promotional events, and marketing to drive more business.

Across the company, we did experience a lift in business during our friends and family days, but the event has made it difficult to make an accurate assessment of the underlying business trends.

There are a few areas of guidance I would like to update you on for the balance of the year.

Regarding SG&A.

We still expect spending to increase slightly for the full year in dollar terms, even though advertising costs will increase 20% on a full year basis, our total SG&A which includes advertising is still only expected to be up about 1 to 3%.

Regarding interest, we expect gross interest expense excluding interest income on cash investments to be approximately $255 million for the full year, somewhat lower than our previous guidance.

Looking at our inventory buys, as we indicated, our plans for the second half will be less conservative than the first half.

For the third quarter, we expect inventory per square foot to be down low single digits to last year, and the fourth quarter up low single digits.

I also want to provide an update regarding the CEO, CFO certification process.

As most of you are probably now aware, the submission of the certifications is due 45 days after the close of the fiscal second quarter, which for us is September 17th.

On August 12th, we submitted certifications for our 200110-K and 2002 first quarter 10-Q.

With our second quarter 10-Q, that is due by September 17th, we will include appropriate certifications.

At this time, I'd like to turn the call over to Mickey.

I'm pleased with the changes we've made and the progress we're now seeing in each of our brands.

As you know, last week, we announced important new roles for Gary Muto and Maureen Chiquet.

I've worked closely with both of them for the past 14 years, and I'm confident we'll see continuity in our strategies and ongoing improvement at GAP and Banana Republic with Gary and Maureen in charge of those businesses.

In each brand, we've achieved much of what we set out to do over the course of the last year.

Our merchandise assortments are more balanced and we're invested in more of what customers expect from each of our brands.

Product, quality, and style has improved relative to each business.

Our stores feel more consistent with what each brand stands for and our customer service is better.

We focused on the fundamentals and the foundation for overall improvement is at GAP, Banana Republic, and Old Navy.

We feel good about our store's look and the customers are telling us they like what they see.

And we're confident that each brand is headed in the right direction.

Traffic remains one of our biggest challenges, making sure our marketing is compelling in delivering the right messages to our customers is a priority.

We're also currently responding strategically and tactically in each business to the extremely promotional environment we're seeing now.

I'll highlight what's happening at GAP brand, Gary will update you on Banana Republic and Jenny Ming will talk about Old Navy, and then we will take questions.

As Heidi mentioned, GAP's fall full assortments have been in stores for less than two weeks.

And our fall TV campaign breaks tonight.

We remain confident in the overall direction of our merchandising assortments.

However, we're seeing a continuation of GAP's late July traffic trends.

The current retail environment is extremely competitive and promotional and these conditions continue to pressure GAP brands overall performance.

Getting the product right for our customers has been our number one priority.

We're offering customers more focused assortments with a clear point of view around key items and classifications.

In areas where we have made the most progress for example, men's bottoms and men's wovens, women's stretch denim, and women's woven bottoms, and men's and women's outerwear and active wear, customers are buying.

For fall customers see the most balanced and brand appropriate assortments we've had at GAP in more than a year.

While we could use more wear in our merchandise, particularly in the women's business, [ICONIC] GAP franchise items and categories are clearly presented and communicated in the store.

For example, customers know we stand for jeans.

We make it easy to find the right fit and the right wash.

As we step up our marketing, customers are learning that we have an exciting new assortment of the right fit and washes.

We've also created a clear point of view and easy shopping environment around other key items such as our jean and [INAUDIBLE] jackets, pea coats, GAP stretch, classic white shirts and our favorite T. These items are performing well.

In our women's business, customers are responding to our new fits and washes.

In jeans, our long and lean jean and boot cut jean are our best sellers.

We've also launched the low-rise boot cut, which is getting great response.

Stretch denim, which is a very key category for us, and stretch I might add also being a key fabrication, the stretch denim is a focus of our women's TV campaign and is doing well.

And stretch denim also offers GAP women's exceptional comfort and fit.

And it gives us a competitive advantage.

We're also seeing a strong response in our bottom business, with items such as the classic trouser and boot cut stretch trouser women's are performing well.

Outer wear and active wear are strong categories with such items as the pea coat beating expectations.

The men's business is performing strongly, and we're confident in how that business is evolving.

We have the clothes men want to wear and expect to find at GAP.

The loose fit jean, which is featured in our print and TV advertising is our number one selling men's jean.

Our khaki business is also doing well as we have reestablished credibility in fits and styles that men want.

All five of the men's fits are beating expectations.

These successes tell us we're moving in the right direction with our key merchandising strategy.

We focused on offering a broader range of fits, washes, and styles and reinvesting in key item categories such as our classic trouser, and fleece and our fleece and active businesses.

These strategies are working.

On the marketing front, we feel good about our for every generation campaign.

This campaign is a key part of our efforts to evolve the brand and reconnect with customers.

The campaign has a strong product focus around jeans, particularly stretch denim for women.

When GAP is right, it connects with a broad range of customers.

And that universal sense of classic, personal simple style is what every generation is about.

Improving the customer experience has been a priority for us.

We've made substantial progress.

We've focused aggressively on product presentation, customer service and general store operations.

Reducing sales floor out-of-stocks, providing better fitting room service and moving customers more quickly through the checkout lines are priorities.

Ongoing point of sale customer research shows it's paying off with improved customer satisfaction.

We've made progress in a number of important areas, but we have more work to do.

Men's is stronger than women's, increasing conversion and traffic are priorities, you'll be seeing more strategic promotional offerings as we address the incredible priced competitive environment.

Continuing to evolve how we speak to customers through our marketing and store environment is critical.

As we manage through the current promotional environment, we're giving our customers more reason to buy at regular prices.

Thank you, and Gary will now update you on Banana Republic.

Banana continues to focus on the fundamentals that made it famous.

Emphasizing the brands casual luxury positioning, and delivering style, quality, and details in our product.

While products improvements will continue to evolve in the up and coming season, we're seeing encouraging signs in the business, with merchandise margins improving year over year and first and second quarter.

We have three priorities.

Improving the performance in our men's business, continuing to develop our women's business and creating a better store environment.

In men's, we've rolled out our new Chino pant program in April, and it continues to perform strongly beating our plan in second quarter.

There are four branded fits, the Smithfield, Gaven, Emerson and Dawson, and the Dawson is the number one seller.

Looking to fall, which arrives week four in August, customers will see these fits introduced into a new assortment of dress pants, stretch wool, flannel and corduroy.

These pants also feature clear improvements in design, detail and quality.

In women's, our pant strategy remains our primary focus and the business continues to perform well.

Of our three branded fits, Lindsey, Harrison and Martin, our number one seller is the newest fit the Martin.

If fall we'll continue to evolve the assortment by offering the new pant fit in new fabrication that include stretch flannel, corduroy and wool.

Capitalizing on outerwear, we've elevated our outerwear assortment through an emphasis on premium fabrications as well as incredible attention to styling details and fit.

We will continue to grow and develop the accessory business.

We are pleased with the response to the relaunch of our jewelry business to selective stores, and plan to roll it out to all stores by holiday.

Both accessories and outerwear are examples of the brands emphasis on wardrobing by dressing the customer from head to toe.

In addition to merchandising, we focus on the customer experience.

We've taken steps to improve the customer service by reallocating payroll dollars out of management and onto the selling floor.

This helps ensure that our stores are welcoming and accessible to our customers.

We have also retrained our sales associates to focus on the key areas where the customer needs to be engaged; the fitting room and checkout.

Beyond these specific areas of focus, the fall assortments will continue to show the progress we've made in simplifying the assortments in improving garment quality.

The fall merchandise assortment has been reduced by 20% over last year and these inventory dollars have been invested in key items to provide a clear point of view.

Our head designer, Deborah Lloyd has elevated the overall design of the products, offering tailored styles, with improved quality and detail.

In men's dress pants, in addition to the improved fabrications, we're adding construction details such as half linings for comfort and split waistband seams to allow for tailoring.

Color pallet also continues to be important at Banana Republic.

While the fall color pallet is based in a mix of classic neutral colors, you will see accent colors used appropriately to elevate the merchandise and store presentation.

In terms of marketing, we were a bit quiet for Q2.

Going into fall we will focus on reengaging our customers and highlighting the must have items of the season.

As part of our recent focus group learning, we'll beguin to market to men's and women's differently, from print advertising to the store level to more effectively appeal to their needs.

For example, this fall we are mailing a 24-page catalog to women and a separate mailer for men.

Last year it was one catalog for both men and women.

Banana Republic remains uniquely positioned to provide its' customers tremendous style, quality, and detail.

I feel good about the initiatives we have in place and we're seeing positive responses, and I feel we're in a position to improve the business going forward.

Now I will turn it over to Jenny for an update on Old Navy.

Good afternoon everyone, we've made great strides in the second quarter.

We're reconnecting with our customers, and this has led to a marked improvement in our results.

The accomplishments are a result of the strategies in merchandising, marketing, the shopping experience, and improving operating efficiency.

I will highlight key initiatives and accomplishments in each area.

In merchandising we have three major strategies, product, investment, and pricing.

In product, we created a filter to aid our merchandising teams in selecting merchandise for a broad range of customers.

Fashion is a key part of our brand, our objective is to reestablish Old Navy as a place to shop for fundamental items at a great value for the whole family.

This was communicated in July through the successful stock-up sale.

We've also improved product quality.

We increased the weight and upgraded the wash in our base fabric in twill, denim, and knit.

There's evidence that these product strategies are beginning to pay off.

During the second quarter, the percent of product we sold at full price and the margin on our marked down goods both increased.

Our second merchandising strategy is reflected in how we make product investments.

We've returned to a dominance in key items for the whole family, such as the rugby offering.

The numbers of styles offered has been reduced by 30%, and reinvested in our top 30 styles.

Finally, we have reexamined our pricing strategy and now offer a more compelling promo price upfront, to communicate Old Navy's great value to our customers.

We have also used a circle to reinforce the message.

In the second quarter to amount of products sold at a promotional price increase while the amounts sold as markdowns decreased, driving up markdown margins.

Our marketing strategy focuses on three initiatives; increasing and reallocating our TV expense, introducing the circular, and increasing the penetration of our Old Navy account customers.

In the second quarter, we increase spending on TV year over year, adding additional weeks and increasing our national GRP's.

As a result we saw healthy change in traffic as compared to the weeks prior to the campaign for the shorts spot that ran in May.

Although are traffic comps remain negative, we feel we're in the right direction with our television campaign, but it may take customers a while to catch on.

A rugby TV campaign that launched last month, featuring the rugby bunch and highlighting a great item at a great price for everyone in the family is a return to the type of campaign that made Old Navy famous.

We've been very pleased with the launch of the circular this year.

It began as a 8 to 12-page monthly insert.

And in August we are moving to our twice monthly four page circular.

This allows us to contact our customer more frequently.

Enforcing our strong value message and showcasing our product for the whole family.

And we have increased the number of Old Navy credit card accounts.

Customers by 31% year over year.

Only the account customers spend more than other customers and are most loyal.

So growing this customer base increases comp.

And our third set of strategies focus on improving the shopping experience.

We have simplified the in store signate to more clearly communicate a value message.

We used to have three types of signs, now we have one.

We have also made it easier for customers to shop by using a consistent set of colors on the curtains for men and boys and women and girls.

And finally we have simplified how we present our goods, merchandising the store by category rather than outfit.

Not only do these changes make the store easier to shop for customers, it makes it easier to merchandise for the sales associates.

And the final strategy is increasing operating efficiency.

We have developed tools to assist our store manager in better planning payroll hours.

Since the introduction of these payroll tools, we've seen an improvement in operating efficiency.

Our stores do not fully control traffic or pricing, but they have a great impact on conversion and unit per transaction.

And we develop a score card that ranks stores according to these two metrics, record-selling performance in both areas for May and July.

June was very good as well.

Although the comparison to last years markdown madness make comping these two metrics difficult.

We believe we make progress in achieving our goals and are seeing the results today.

As we head into the back half of the year, I'm confident that Old Navy will continue to build on the progress.

Thank you.

We'd like to open it up for questions.

At this time, I would like to remind everyone in order to ask a question, please press star, the number one on the telephone keypad.

If at any time throughout the conference the question has been answered, press the keypad to withdraw.

We'll pause for a moment to compile the roster.

The first question comes from Jeff Kleinbelcher at U.S.

Bank Corp Piper Jaffrey.

On the cash flow, can you give us some perspective of what you're looking for operating cash flow for the next couple of quarters and maybe a first blush at next year.

And Mickey, on the men's product sales, we've been hearing from a few people, especially when there's a value component, that sales are picking up modestly, do you think you're benefiting from this as a secular trend.

I'll take the cash flow question.

I am pleased with the first half performance so far, it's a modest cash flow improvement, and of course our cash position is extremely strong.

We have roughly $2.4 billion of cash on the balance sheet at the end of the quarter.

And as we look to the remainder of the year, I expect to have the normal seasonal pattern, where the third quarter is a negative cash flow quarter for us, and then really most of our total year cash is generated in the fourth quarter as the holiday sales proceed.

So when we started the year and we were talking to people about cash flow for the company, we'd always said that we can generate pretty strong cash flow with mediocre earnings, and I feel good at this point in time, certainly we need earnings to hold up to some degree, that we're on track to generate positive cash flow for the year.

Certainly we have a major reduction in capital spending, which is contributing to that.

But I think also we've been able to hold on to working capital improvement that we saw last year, not promising any further improvements this year.

Well, overall, I feel quite good about the cash flow position and liquidity position, and cash flow and liquidity outlook.

We're not ready at this point to talk about any 2003 guidance.

So Mickey?

Regarding the men's business, what we're actually finding is we have a much better response to the merchandise that we have in our assortments.

We have what men want this year.

So we're pleased with the results we're seeing.

One of our key items is the pique polo which a promotional item and a value item, and that has been incredibly successful.

Beyond that, the other items are doing well because we're in stock and we mentioned the five men's fits we have in twill, are in stock.

We have running a $10 off Jean event.

We're pleased with the acceptance of merchandise in men's.

Thank you very much.

The next question comes from Robby Omes of Morgan Stanley.

Thank you.

First I just want to congratulate Gary and Maureen on their promotions and ask them to outline for us how the approach of each of you might differ from your predecessor in your new roles.

And the second question.

There's a lot of comments about the promotional activity being more aggressive out there.

Can we get comments by division in terms of, is the level of competitive promotional activity similar across all divisions and is the level of competitive pressure by category similar meaning, are there specific categories and merchandise that people are being more promotional than owes?

Gary, do you want to go first, and while you're answering, maybe you can answer both questions for Banana Republic, answer the promotional part.

Sure.

As far as my perspective, I'm in the early days of transition and I am evaluating the business.

But from the outside I do recognize that GAP has done a tremendous job over the last several months balancing these assortments and getting the product right, and they've made in store improvements.

I'm excited to work with the new team that's been in place.

Gap is a well-known apparel brand, it has tremendous opportunity and we need to work to reconnect with our customers to revitalize the universal appeal.

We need to make sure that we develop a clear and consistent and compelling marketing campaign to get the customers back and re-engaged.

My first priority is to find a head of marketing that can provide a strategic direction.

Over the next few months, I will develop my priorities and I look forward to communicating that with you in the near future.

As far as the competitive landscape out there, and I will speak to Banana Republic, we at Banana Republic need to be very, very careful.

We're happy with the margin improvements we've made in Q1 and Q2.

And I don't want to erode the brand equity that we've built up over the last year.

So I think we have to be very, very careful out there.

There was some promotional activities out there, percentages off.

And at Banana Republic we do what we need to do from a competitive point of view.

We're not looking to do anything radical at this point in time.

Our fall merchandise starts the last week of August.

That's really our major selling scene.

I will turn it over to Maureen now.

Gary has built a strong leadership team at Banana Republic.

And they have done a lot of work already in re-positioning the Banana Republic brand, really focusing, as Gary said, on the casual luxury, so that style has driven customers.

They've began to elevate the brand by offering better fabric, styling, and better pant fits.

We're starting to see some of those results.

I feel Banana Republic has an opportunity, and will continue to evolve by attracting a more grown-up customer and really becoming their trust and style editor.

BR has great potential due to the brand positioning.

And it has an ability to offer all components of the wardrobe to customers, casual, dressy, shoes, accessories.

I look forward to taking Banana Republic to the next level.

To finish out on the promotional question...

I don't know if you care to add anything unique on your brands about what's going on in the marketplace?

Yes, I'll take that.

This is Jenny.

Old Navy is a value brand.

Our circular has provided us an opportunity to talk to our customer about the great value.

All of our promotions are very much planned.

And I think you're feeling it in our store with our signate package that we're strong in our promotional message.

With regard to Gap, I think we're feeling competitive pressure, especially for the back-to-school business around things like denim.

We're happy that we were prepared with a $10 offer.

And for the most part, I think we're going to stick to our strategy of making sure that we've put back in our stores what our customers expect from us.

I'll round it out.

This is early on in the new season, in planning third quarter, particularly during what's kind of an unpredictable month for us, we have a lot of built-in value promotions that we have kind of a just in case plan.

We're looking at it very strategically, and very selectively, but I think as you look around the market place, sometimes it's hard to understand specifically what is being promoted in certain of the companies because there is two floors in a lot of cases, there's buy one for an extra dollar.

We're being very competitive.

We don't want to not take advantage of our strength in the marketplace, and given the environment, we have to remain as competitive as we can.

Is it wrong to say that the impact from this competitive environment looks like it's hitting GAP harder than Old Navy or Banana Republic?

I think that's difficult to say, because we are seeing the difficult traffic trends in both GAP and Old Navy.

And I think that both brands feel that as the month goes on, they need to be a little bit more aggressive with certain types of promotional vehicles to get people into the stores, so I think that would be hard to say.

Thank you very much.

The next question comes from the line of John Morris of Girard [INAUDIBLE].

I've got a question for Mickey, actually.

I think just to start.

I don't mean to be flip, but you did talk about a lot of things that were selling very well in the early stage for the second half of the year.

What isn't selling quite so well?

And then can you give us a sense of the direction that you'll evolve the merchandising, sort of after the initial focus of the denim, that will help maintain excitement for the customers as we get into holiday.

That's not flip.

What's not selling as well is heavier goods.

For example, we have a great v-neck ribbed sweater, which we took a very large position on, it's selling a heck of a lot on an absolute basis, but it's probably a little early for the maximized selling that we'd like.

The fashion denim business is not doing well.

That's more the novelty.

Not five-pocket business, and we needed more sleeveless T-shirts.

We're missing business on that.

I'm going to ask marketing to show more detail on that.

We have new delivers after Labor Day.

So there's constant flow in all our businesses throughout the balance of the season.

And I think you'll see stepped-up intensity, particularly in the GAP brand, in color and in new goods coming in on September 9th, I believe.

Do you want to add to that?

No, I think Mickey did a pretty good job on that.

I think we wish we'd been heavier invested in short sleeve.

We have more inventory in sweaters and long-sleeve than we wish, so those categories aren't as strong as we want.

And overall we are little bit disappointed in some of the denim sales.

We're definitely happy with the strategy we put forward in putting fashion washes or darker washes in basic silhouettes the five-pocket silhouettes, but the younger styles we did for back-to-school were not great.

And I think we wish we had more velocity coming out of denim, and that would be the two areas that are strongest.

There's nothing so dramatic that we feel a course correction involved, and we always knew there was a bit of a struggle with some of the color pallet in fall, and that's something that's easy, and we have a new pallet for December 9th.

One other thing I'd like to add if you look at all three businesses relative to a year ago, when we went in a direction that is wasn't as appropriate.

Our inventory investments are invested in merchandise that we evaluated in a much different way, it's more profitable investment in inventories, because we're not dealing with a huge amount of SKU's and assortment on the fashion and novelty level.

Even on a ribbed v-neck sweater that was selling tons of but maybe 20% less than we would like to sell 30%, those goods always have built in safety valves of margins.

And they're pretty good goods if not at a regular price then at a value price.

We're pleased with the downsize in a lot of these investments.

Just had a quick follow up for Heidi.

Assuming we can get back to positive comps in the back half of the year, on the easier comparisons, would SG&A, because of the advertising spending, still likely to be up as a percent?

And if you could give us the tax rate assumption we might use in the back half.

Thank you very much.

We're not changing the tax rate assumption at this time.

That's something we evaluate every quarter.

So we will again evaluate it as we close the third quarter f we feel at that time our projection for the year based on the level and mix, geographic mix of earnings warrants a change, we would announce it at that point in time.

As far as SG&A is concerned, really our SG%A or the back half is, as I mentioned -- well, we've talked about it being up like one to three percent for the year as a whole, this means a considerable increase in the back half given our performance in the front half, and that will be largely driven by some pretty significant increases in advertising.

And that's baked.

We're planning to do those.

We'll see probably $55 million more in Q3, $20, $25 million more in Q4 in advertising.

So that's baked.

And the other big variable in the increase in SG&A in the back half is going to be related to our unit sales, and meaning store payroll and benefits, D.C. variable costs and things like that that vary with the unit sales.

And being that we bought the back half, that's pretty well baked as well, other than if you of course if you do better your velocity is faster and so even if you bought a fixed amount of inventory you couldn't sell more of it.

So I would say that's the kind of area that could have some further variability in it.

Next is from Dana Cohen from Bank of America.

The first question, Heidi: Since traffic and comp don't necessarily correlate, I presume your using traffic as a proxy for comps and that comps has not picked up versus where you were trending in the back half of the month.

Second, if business were not to improve; there anything you could do on the inventory to potentially bring them in in the back half?

And then third, reading in between Jenny's comments about how people really came in for the promotion for the back-to-school, it doesn't sound like they're responding on the rugby as much, does this raise a question on the use of the marketing dollars that maybe there should be a reduction or reallocation to more promo versus image advertising?

Well, on your first question, no, we weren't trying to use traffic as a proxy for where our comps are this point in time.

We were commenting on traffic because obviously that's one of the four comp leavers.

And that's the one that's disappointing us.

We're seeing some in Banana Republic and Old Navy, some nice levels of conversion and units per transaction.

Depending on the brand we're seeing nice movement in average retail.

So I wouldn't want you at all to walk away thinking that's where our comps are running to date.

That's not what we're saying at all.

What we're saying is that, that's the disappointment to us in the first couple of weeks as we look across the levers.

And part of that, we do believe is related to perhaps people being louder in the mall in terms of their promotional activity.

And obviously, we've got an ability to pull triggers on generating much more traffic in the back half, and hopefully that will drive business velocity.

As far as the second question is concerned...

I think you have to repeat it.

Let's assume business doesn't get better, throwing that up there.

You've said your inventories would build.

Is there any flexibility you might have in the back half?

Our inventories are pretty well bought for the back half.

I would say two things.

First of all, you need to recall that last year, our inventories were bought before the year before, so just the fact we'll be up in the back half versus last year, versus two years ago, we're kind of flattish, so I think that's one way of expressing that we I still think that these are conservative levels of financial investment, and then I think Mickey's point that he made a couple of minutes ago is really, really relevant, because it presents us with a much more manageable situation if overall demand is weaker in the back half than we had on our hands last year.

And then you had a marketing question that sounded targeted at Old Navy.

So maybe Jenny can take it.

It was for both.

The image advertising is not being effective.

It sounds at Old Navy, but didn't work for the GAP recently, and does that force you to reassess the total marketing dollars or how it's being spent?

Let me make a couple overview comments, and I think they are grandesque answers, and so probably Jenny can answer for Old Navy and Mickey can speak to GAP.

But we are very focused on measuring the effectiveness of our marketing dollars.

It's a large amount to spend.

I think our tools are better now than they were a year ago.

And I think that you're probably right, certainly in the GAP brand so far, we haven't seen the usual lift in traffic from television that we would have liked to have seen.

But I would say, though, that television is most equitative historically in Old Navy, but it is still quite effective for GAP brand.

And we've spoken before that we need to retain some level of commitment to our marketing as our product develops, so that -- because it is a highly effective way to communicate with our customers, so when we look at it over the long term, we feel satisfied that it paid off.

We have to get to the point where the campaign gives us what we need.

I don't disagree with you at all there.

We are in a transition stage here where we have to have a little forbearance on the RLI.

I was very pleased with the summer short campaign.

It gave us strong traffic comp that I was looking for.

And as for traffic generator for the rugby campaign has been below expectation, but it's still very early.

Although I'm pleased with the direction of the creative and heard very positive feedback from the rugby campaign.

The customer awareness cited that the rugby bunch had the highest recall score for an ad.

So that's running ahead of plan.

TV does drive traffic.

And not only that, it sells the product.

And plus the circular adds to the traffic, it's a double whammy for us.

And I'll finish up on GAP.

I think Heidi said it perfectly.

The TV campaign kicks off tonight, and the call to action on TV, and I think it's a good issue about advertising and it's payback.

I think GAP has disappointed customers for longer than we've all been happy with.

The assortments reflect where we should be again, and we want to take a step backwards on our investment in getting that message out.

The call to action in women's is stretch, and stretch as a competitive fabrication in our marketplace, I cannot tell you how important that is to all of our customers, particularly customers who are the GAP and above levels.

It is a very, very important piece of our business.

We have a lot of history in the.

And the entire women's message will be stretch, and it's said in a way that will hopefully also gain lots of recognition.

So that's kicking off tonight.

We'd like to them to know, that if you need stretch jeans, and I don't have to tell the women on this call how important that is in stretch, that's starts tonight.

The print campaign kicked off a few weeks ago, and traffic is disappointing for us in all our businesses.

And GAP has been in the promotional mode for so long now, that we have to get customers to know we have regular-priced goods that they want that they won't see on sale the next week.

That's kicking off tonight.

And the men's campaign talks about the loose fit.

And the personalities you will see speak to again the customers that we have alienated at the GAP.

And the personalities which you can see online, if you're curious, will give us a strong messages about the strengths we have in these categories.

Thank you.

The next question comes from the line of Richard Balm of Credit Suisse First Boston.

My question doesn't relate so much to the current quarter, but listening to some of Heidi's numbers in terms of the productivity being down once again this quarter, the fact that you are running with more focus assortments, fewer SKU's, more commitment to each of those, and when I look at the inventory square foot versus two years ago, it's down 25%, and you're comfortable running the business at that level.

The question is: Given those three factors, it seems like the average store size could be about 20 to 25% too big, if this is the way you want to run the business and run it profitably.

You haven't really commented too much in the past on that as an issue.

I'd love to hear your thoughts on it today?

I think we've commented on it in one respect, because the question is often asked about store closures.

And our position remains the same as we evaluate our stores for lease actions, we do a full model on it and if it chiefs our hurdles, we will extend the lease, and if it doesn't, we will close the store.

And we expect the store closures to be at about the same level as we saw last year.

And we do not have a major issue in terms of negative cash-flow stores, which is critical when we're talking about approaching our stores on a lease by lease basis as the maturity dates come up.

You're making absolutely the right point.

We need to get our productivity levels back to -- we don't need to get them back to the levels we saw in 1998 and 1999, but we only consistently saw productivity numbers in the low to mid fours for many, many years throughout the '90s.

And we need to get it back to that kind of level.

And I think there are two things embedded in it...

It's not just the sales dollars, it's the margin dollars.

I want to add one thing on that.

We used to house too much inventory in our stock rooms.

And we have D.C.s that can help us get a better return on investment.

It became some and what manageable.

We're much cleaner now and the stores can more effectively handle the inventory.

We see this as an opportunity.

The level a we had at one point was the accurate level, then we wouldn't be at the level we are now.

But we looked carefully at the inventories last year, given the assortments we had, it was a blessing we had much less inventory, but we felt confident to go into third and fourth quarters.

And something to add to that too is that some of the increase in the inventory per square foot that we saw, it increased quite significantly in the late '90s, was in an effort to always be in stock in basics, pretty much.

And we didn't do that probably the smart way.

And we had some better forecasting tools now, and we're working on more tools, so that we can have the right in-stock position in the goods we have all the time and people expect us to have in their size all the time with much lower inventory levels.

My one follow-up question on that would be whether you think you can get back to productivity levels running inventories down 20% on average from where you were two years ago.

The inventory will likely go up as business performance goes up.

Richard, I have the store manager here who I think knows more about inventories than some of us in a seps.

It's Marcy.

And we are actually having a much easier time presenting and handling the inventory.

As we look at our competitive set, Gap was behind where we should have been on weeks on hand and inventory turns.

We made a decision to get a better return on our inventory investment.

That's a company initiative.

So we'll see what happens.

Thanks.

The next question comes from Marsha Aaron of Pacific Growth Equity.

Can you talk more about the back-to-school set, and it feels like you may have walk away from the teen customer.

And I know you're trying to present a broad spectrum for a broad range of customers, but I'm curious as to how you feel you addressed that younger age group through the back-to-school selling season.

I don't -- the younger age group is actually a group that alienated -- when we address the underage group, and I'm not sure what the influence of a rot of young teenage clothes had on us last year.

When we went young, we alienated an enormous group of customers, including teenagers who came to expect certain points of view.

A lot of teenagers are wearing our low rise boot cut jeans and a lot of them are wearing our jeans in general.

One of the biggest businesses we have is the carpenter jean, which is probably the [INAUDIBLE] jean in America.

It's a famous monster at GAP over the last couple of years.

If you go into the stores, you'll see the carpenter in -- how many washes do we have it in now?

Probably six.

So it's doing very, very well.

You have to have a point of view.

We have the shopping in the stores, but we couldn't cleat completely meet our needs by catering to that market.

And we have strong teenage competitors, and in fact, we felt for us to continue to grow our GAP brand profitability, we didn't want to change the focus to the teenage customer.

And I think we're right.

And teenagers wear our clothes because they can wear our teenage tank tops and carpenter jeans.

And we have a worker jean.

So it was a strategic decision we made.

As we shop the competitive environment, and we do it all the time, last year we didn't have a reason for being at the GAP.

We had teenager young assortments.

I think they've done a nice job of catering to the teenager.

But when it comes to getting the best five-pocket assortment, and the carpenter assortment, and those are important trends in the teenage world.

And among the best t-shirt assortment, we're able to cater to a tremendous amount of teenagers, their older sisters, and fathers.

When GAP is right on assortment it does transcend generation.

Can you talk more about the tops business, it sounds like our doing better on the bottom side than the tops.

Part of it might be the wear now factor.

But are there other initiatives in color that you're trying to do to improve the top business?

We started when I came to the brand in March of last year, a lot of things were set for fall, and we were continuing to improve those things.

Color was one of the things we felt we missed a bit on.

That's what drives the knit business.

So we're a bit disappointed with the in the business, as well as color, we had misses on color.

So that's something we went into the season knowing full well, was an issue.

So I think that would be the best answer to that.

So we should see changing in the color in September?

September 9th and on through the holiday as well.

Great, thank you.

The next question comes from the line of Emmie [INAUDIBLE] Sanford Bernstein.

You said men's is performing better than women's.

Is that how the quarter ended or just recent trends and why this is happening?

And in women's, you've had a price increase.

And will you be keeping that range.

And during the call, I received a $20 off coupon on GAP stretch boot cut jeans.

And I was wondering is it considered one of the fashion denims that you're disappointed with?

I'm going to let her answer the details.

We did sent out e-mails today, during the call we can't sit back during back-to-school in this environment and let our competitors take some of our business away.

I've shopped the stores today around Manhattan and a number of our direct younger competitors, and maybe that's a back-to-school market, and I say we have goods for them, are giving lots of dollars off on lots of their jeans.

And we said at the beginning of the call, we'll look marketplace and take advantage of the power of the GAP brand.

We can do that more effectively now that we have probably the best selling jean in America's marketplace in the boot cut.

It's probably the number one jean.

This might be a bit of a statement, but I don't see every competitor's information, but we felt we're not going to allow people to take our business away from us, when we have the ammunition that we have.

I'm glad you noticed the e-mail.

And if you want to answer the rest of the question, that would be helpful.

On the men's business, yes, this is the -- we finished the second quarter with men's finishing in a strong position.

As soon as we were able to get back into the businesses that the customers expected from us, the classic T-shirt businesses, the basic shirt business, the khaki presentation, the commitment to jeans, we saw it pop quickly.

And that's something we're seeing week in and week out.

We've given them what they wanted.

With regard to the $59.50 price point in women's jeans, we're seeing no price resistance in denim, if it is the right finish.

And we're finding the darker finishes and the upgraded finishes, there's no price resistance for the right finish.

So that's the only area where we're struggling is in the commitment we made to the teen fashion patch pocket jeans.

It's more about finish than about fashion styling.

And then the $20 off promotion, you can e-mail it to a friend.

Thank you.

I was going to add...

The wash -- there's a stretch factor and wash factor in all of our denim.

And we want people back.

Our campaign kicks off tonight, but we recognize when you're not right for the affidavit year or so, it's important to have people wear our clothes again.

Thanks.

The next question comes from the line of Mark Freedman of Merrill Lynch.

Good afternoon everybody.

Mickey can you talk more about -- you guys talked about conversion at Old Navy and Banana Republic,.

You didn't address GAP on the conversion side and adults versus kids performances.

Is there much of a difference there to date, in August?

And spring 03 planning, are you looking at luring in more fashion as you get further out?

Let me start with the last question fist, and I'm going to ask Marka to respond to conversion on the kids thing.

I think we've said on our sales calls that adults has been under performing kids and that continues to be the case, baby does best, then kids, then adults.

And the other piece, at GAP, during the last number of weeks, the average retail of GAP goods moving out the door because of our enormous pro-managing activity was lower than this year, so that probably drove a fair amount of sales shoppers in the store.

You will see in terms of the market will add to that, you'll see if what you're saying is that the goods need to be more spiced up, we are working on that, for sure.

September 9th delivery will in fact show that to a degree, and I think as you look at fourth quarter holiday, even more intensively, I think the GAP business relative to the change in management we put into effect -- the management was changed in January when we all came in and took over.

So I think you'll see a much more intense assortment of more appropriate GAP fashion goods than you see in the stores right now.

And I think September 9th will be the beginning of that change.

Thank you.

And then just to follow up on the conversion.

Are you manage that because the con converse in the past was benefiting from the sale merchandise in the store, it makes a tough sequential comparison?

there's no real big problem on that.

I think there's an opportunity on conversion, it's something we're working on.

But there is a correlation obviously, mark, so it will -- we do believe that -- because we do have significant differences at this point in time in average retail, given how deeply we marked down things last year, we believe there is certainly an impact on conversion rates.

But ultimately, we believe that we can have -- that conversion should help us weather the period of time it takes to get traffic to the positive area, just as we've seen in Banana Republic and Old Navy.

Where traffic still remains negative, but the comp store sales are out performing the traffic.

Thank you.

The next question comes from the line of Stacey Pack from Prudential Securities.

And I was wondering first if you could tell us if the progress you've made on the conversions, on the UPT, has led to an improvement in comp overall in August from July?

Could you say that again?

You've said you made some progress in conversions and UPT, et cetera, I'm wondering if that progress, despite the traffic not improving, it if has led to an improvement in comp from early August from the number that was reported in July?

We did not give a comp number for the company so far this month.

I know, that's what I'm asking for.

I don't think I can answer your question.

Okay.

What we intended to say is we're under performing our plan for this part of the month, you know for the first ten days.

But you did just say that Old Navy and Banana Republic's comp are better than their traffic, right?

No, I said over the past several months, Old Navy and Banana Republic have been able to see better performance in conversion and UPT's to offset the negative traffic they've seen.

I wasn't being specific to the first ten days of August.

And you don't want to be?

No.

How about IMU opportunity in the back half?

We think there is some IMU opportunity in the back half.

In the GAP brand, we think there is less, because we've made some intentional investments in the quality of the goods in the back half, when you're talking about like for like products.

You can have some mixed changes that change your IMU.

We're seeing some sourcing savings, and we'll be reason vesting dollars in the Gap brand.

how about the other guys?

A little bit.

And I heard loud and clear men's doing better than women's at GAP.

Can you speak to that at both Old Navy and Banana Republic and also speak to sweaters, the performance of sweaters at Old Navy and Banana Republic?

Why don't I pass it off to Gary and Jenny, that would be great.

At Banana Republic, the business is starting to turn around, so we're pleased with the results we've seen there.

Regarding the sweater business, I think it's too early to call right at this point in time.

For Banana Republic, the season really kicks in the end of August, the beginning of September.

Old Navy men's is actually doing very well.

We're happy with it.

But we have a lot to make up for.

Regarding sweater, we don't do a huge sweater business in August.

Sweater kicks in, in the later part of fall.

But to summarize, the out performance of men's is more pronounced in GAP than the other two brands.

Does anyone want to comment on the progress on the CEO search?

And has there been any clarification on the timing of the search?

We don't have anything to add to a we said before.

We talked about who is helping us with the search and the kinds of things that we're looking for.

But beyond that, we don't want to speak publicly about it until we've got some decisions to announce.

Thanks.

The next question comes from the line of Dana [TELSEY] of Bear Stearns.

a Couple quick questions: The change in expenditures allows, can you comment on which initiatives are receiving capital.

And on gross margins, given the environment out there now, how do you see the gross margins going forward.

Was it more IMU or less markdown sales?

Any comments, Mickey, on corduroy, GAP body and special sizes?

And how long will forever every generation be out there for?

Will that take us through the holiday season?

That was a lot.

We may have to ask to you repeat some of those.

The Cap Ex, and the reallocations into IT we've decided to pilot project that is we probably would have get on the back burner.

Some of the initiatives under way that will get more investment dollars to accelerate introduction of features, one would be global financials.

So that will help us speed up our time table.

And we're adding dollars to accelerate some of the phases of the reteach implementation that we're doing.

As far as gross margins are concerned, more promotional activity has an impact on gross margins.

But as we look to the back half of the year, the comparison does become extremely easy for us.

And I think to say yet again the type of inventory that we have, we think we're much -- in a much, much better position to manage our gross margin level dollars and our level of promotional activity than the kinds of products we had last year and the proliferation of products that we had last year, which really pushed us into a corner at many times.

So we still are very hopeful that we can continue the trends we have recently seen of year over year margin improvement, that's clearly our objective.

We haven't brought our inventory levels high enough to generate a lot of comp.

So we're looking at it from the gross margins line.

This is John Lillie.

One of the main things we're doing is looking at some opportunities for enhancements to our POS systems.

And we're emphasizing accelerated investments.

This will be early research dollars that will allow us to accelerate the rate of progress in 2003.

And then you had a merchandising question?

Corduroys, special sizes.

Exactly.

In terms for for every generation, we'll continue that right now through the balance of the third and fourth quarter and revisit it beyond that.

Marka, you want to take that?

The corduroy.

Special sizes, we're not doing anything at this point.

The corduroy doesn't come in, and -- we have stretch corduroy jeans jackets that we're excited about, but it comes in for fall, too.

And we don't know what you mean by special sizes, but large sizes tends to be in the Old Navy brand and we have petite offerings in Banana Republic, and I don't know if your question was broader than that?

How are they doing?

Are they being brought into the stores at all also?

Jenny, maybe you want to respond since your brand represent that is most.

a Franchise item, especially in women's, we carry up to size 20, but we carry more extended sizes in other product in our online channel.

And it's doing well.

We're pleased with that.

GAP Body, any idea on how that's going?

It's been building a much bigger impact in the foundations business and building a best in class foundations and GAP Body strategy.

So I third they're pleased with what they've done in terms of lounge wear and as they keep continuing to build on basic bra fits and they've had great success in the panty business they've invested in.

And it's all under implementation.

And to add on to that.

The other part is the cozy lounge wear, which is a natural extension of in-home wear, and that's an important part of the growth plan.

we'll take one last question.

Your next question comes from the line of Todd Slater of [INAUDIBLE].

Good evening.

I'm wondering if you can remind us when you begin lapping the work force reduction cost savings initiative?

July.

We took all of the charges in Q2 of last year.

So they've pretty much run through.

I'm wondering if any of you could comment on how you view the impact the days between Thanksgiving and Christmas.

I think Marka, that might be a good one for you or Jenny.

I don't think that there's anything in particular that we're very concerned about.

We find the holiday period starts later and later every year.

We've reworked our slow rat to bring it in closer.

We have strategy now for the consumer shopping for themselves in October and not delivering full holiday until December.

So we feel confident that we can maximize holiday business based on product-slow strategy.

I agree.

I think customers are buying much closer to need, so we're pretty much mirroring that same slow strategy.

Are you planning a bigger December versus November given the fact that the week comes out of November, post Thanksgiving?

As we get closer to that time of year, if we see that we should be guiding on any significant differences in November versus December, like we have historically on Easter shifts, we would be doing that, later in the year, as we get closer.

How about talking about the current thing on the longshoremen situation, if they were to strike and what the effect or impact might be?

John, will you take that?

This is John Lillie.

Yes, I'll take that.

We're tracking that closely.

And I came from being in the industry, having headed up one of the companies that's involved.

We have a number of plans in place on an ongoing basis to make sure that our product is getting here on a timely basis, in case there is any interruption.

My experience says that even if it does come to a strike, usually that's a very short process, none of the parties can stand to strike for very long, including the U.S. economy.

Right.

Okay, and then lastly, I'm hoping you can clarify one item you talked about in the call.

And that was your strategy on narrow versus never out of stock.

And at one point, you were focused on never out of stock, and you went deep into sizes and then you got too deep and had to cut become and felt you needed to reduce that.

Are we reaching a middle ground between the original strategy and the strategy today?

Yeah, it's Mickey.

I would like to think so.

With trying to be 100%, instead of being 96 and 95% -- of course, the online business has changed that issue to a degree.

But we were overly focused on not being out of stock.

And this is an issue with inventories two years ago, we saw slow returns on our inventory investments.

Woe weren't trending or chasing into the kind of assortments at the end of the day drive customers and comps more effectively.

And I think that was an issue that we, in measuring inventory returns, and the amount of inventory that stores have in their stock rooms, we felt we'd rather be good than exactly perfect on that one, and that would enable us to get a better use of our inventory investment.

So it's somewhere in the middle right now.

That conclude our conference call for today.

And as always, the Investor Relations team is available for follow-up questions. 415-427-7100.

Thank you for participating.

This conclude today's Gap incorporated second quarter 2002 earnings release conference call.

You may now disconnect.