蓋璞 (GPS) 2003 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Gap, Inc. first quarter conference call.

At this time all participants are in a listen-only mode.

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Your participation represents your consent to these 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 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 Sabrina Simmons, Senior Vice President of Investor Relations.

Good afternoon, everyone.

I'd like to welcome you to Gap, Inc.'s 2003 first quarter earnings conference call.

For those of you participating in the webcast, please turn to slide two.

I'd like to remind you the information made available on this webcast and conference call contains certain forward-looking statements which reflect Gap, Inc. current view of future events and financial performances.

Where ever 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 in the company's future results of operation can differ materially from historical results or current expectations.

For more detail on these risks please refer to the company's annual report on form 10-K and or other filings through the Securities & Exchange Commission.

The presentation includes a nonGAAP measure, cash flow before financing activities, which under SEC REG G we are required to reconcile with GAAP.

A reconciliation of cash flows before financing activities to our first quarter 2003 statement of cash flows is included in our first quarter earnings press release, which is available on www.gapinc.com.

This afternoon we're going to try to keep the call at about an hour in length.

We'll begin with Byron Pollitt our Chief Financial Officer discussing our first quarter financial performance.

Then Paul Pressler, our Chief Executive Officer will provide an update on companywide priorities and accomplishments.

Paul will also give brief highlights of Old Navy and Banana Republic and Gary Muto will comment on first quarter performance at Gap brand.

After Gary's comments we'll open the call to question.

Now I'd like to turb the call over to Byron.

Thank you, Sabrina.

Good afternoon.

Looking at the first quarter, we are pleased with our performance and momentum.

Customers clearly like what we're doing, and our turnaround continues.

Gap and Old Navy were the primary drivers of first quarter sales and earnings.

Traffic remained challenging but other performance improvements allowed us to produce positive comp store sales.

Specifically more compelling product assortments led to improved average unit retail and units per transaction at Gap, Old Navy, and Banana Republic.

At Gap and Old Navy, strong marketinging drove higher quality traffic, and our emphasis on customer service helped increase conversion.

As a result, merchandise margins improved for the quarter.

We sold more at regular price, and markdown margins were higher.

Let's look at how these efforts translated into first quarter results.

For webcast participants, please turn to slide three on earnings performance.

First quarter earnings were $202 million or 22 cents per share compared with $37 million or 4 cents per share last year.

Our convertible note was diluted for the quarter.

Improved sales, gross margin and a more favorable tax rate drove this significant earnings growth.

Our effective tax rate was a more normalized 39% compared with 49% for the first quarter last year and 40.4% for fiscal 2002.

Now let's look at the underlying drivers of our business.

Please turn to slide four, sales performance for first quarter.

Total sales were $3.4 billion, up 16% from $2.9 billion last year.

Consolidated comp store sales were up 12% compared with a 17% decrease in first quarter 2002.

Sales productivity improved 13% to $87 per average square foot compared with $77 per average square foot last year.

Looking at comp store sales by division for the quarter.

Old Navy, up 16% versus a negative 18 last year.

Gap U.S. up 12% versus negative 20.

Gap International up 13% versus negative 19.

And Banana Republic up 1% versus negative 9.

For first quarter total net sales by division, please refer to our earnings press release.

Turning now to gross margin performance on slide five.

For the quarter, gross profit increased 45% to $1.3 billion.

Gross margin was 38%, up approximately 8 percentage points from last year.

Here is what drove our gross margin gain.

Six of the eight points came from better merchandise margins.

Our stronger product assortments drove more regular-priced selling and better markdown margins.

Favorable shall notting results from annual inventory counts completed in first quarter also contributed to our marling in improvement.

The remaining two points came from the leveraging of rent, occupancy and depreciation expense.

Turning to first quarter operating expenses on slide six.

As a percent of sales, operating expenses were 26.5% flat to last year.

More advertising expenses and higher bonus payouts compared with last year offset better store payroll efficiency in first quarter.

In line with our previous guidance, operating expenses were $889 million, up approximately $120 million or 16% over the prior year.

Advertising expenses were $101 million, up $23 million over prior year.

This increase was due to Old Navy, which used more TV and distributed mor circulars, and Gap, which shifted its TV campaign to spring this year from summer last year.

Total first quarter advertising expenses were below our previous guidance.

Marketing production costs were lower than expected and we canceled some TV during the start of the Iraqi war.

Turning to inventory on slide seven.

We ended first quarter with $2.1 billion in inventory up $319 million versus last year.

Remember, inventory levels were quite low last year.

We were aggresively liquidating underperforming products.

We also intentionally restrained inventory investments until the second half of 2002 when product assortments improved.

On an absolute basis, inventory per square foot was $55 at the end of first quarter.

This is still below our peak levels during 1999 to 2001, and we expect to bring this number down over time.

On a per square foot basis, inventory is up 17% compared with a 24% decline last year.

Although levels are somewhat higher than expected, we are comfortable with the overall composition and quality of our inventory.

Compared to last year, we ended first quarter with less spring merchandise and less inventory at markdown.

Please turn to slide eight for more detail on capital expenditures and store count.

First quarter capital expenditures were approximately $56 million down 42% from the $97 million spent during the first quarter last year.

This lower spending is driven by reduced capital spending for new stores.

Regarding square footage, net square footage increased about 1% over prior year.

We ended the quarter with 3,105 locations or 4,241 concepts.

Please refer to the press release for a summary of our end of quarter store location and concept counts and square footage by division.

Please turn to slide nine as we walk through the key components of our cash flow performance.

After-tax cash flow before financing activities was an outflow of $75 million compared with an $18 million outflow last year.

The higher year over year outflow is due to increased working capital uses related to inventory purchases, bonus payouts, and an international tax payment that we expect will be refunded in the future.

With regard to financing activities, we paid off a $500 million note, and we ended the quarter with $2.8 billion in cash roughly equal to our outstanding debt.

Turning to slide 10.

I would like to comment on our outlook for the second quarter and the rest of the year.

Looking at operating expense dollars for the second quarter, we expect a year over year increase in the mid single-digits.

This is because of increases in variable costs associated with higher unit sales.

For the first half of 2003, we still expect operating dollars to increase 9 to 11%.

Regarding advertising, for the first half of 2003, we expect to spend about $5 to $10 million more than the prior year because because of Old Navy's increased advertising in the first quarter.

This amount is about $10 million less than our previous guidance.

The savings is from lower marketing production cost and the decision to cancel advertising during the start of the war with Iraq.

With regard to interest expense, we still expect gross interest expense for the full year to be between $250 and $255 million, approximately $60 to $65 million each quarter for the rest of the year.

Turning to tax rate.

We now expect the effective tax rate for fiscal 2003 to be 39%.

Our mix of domestic and international earnings and overall level of earnings may cause this rate to fluctuate higher or lower by about a percent.

So any fluctuation would result in an anticipated effective tax rate of 38 to 40 percent.

Looking at our inventory buys for the second quarter, we continued to expect inventory per square foot to be up in the mid teens.

In the third quarter, we expect an increase in the mid single-digits.

As we have said before, we began to buy more inventory in the second half of 2002 as product improved.

Therefore, the year over year change in the second half should be less than the first half.

Regarding capital expenditures, we now expect capital spending to be $300 to $325 million for the year.

The reduction from previous guidance is driven by more moderate growth in IT spending, now expected to be about $140 million for the year.

Store capital is estimated at about $150 million, with approximately $35 million for new stores and $115 for remodels.

The remaining $35 million balance will be split between headquarters and distribution centers.

Looking at real estate, we still expect net square footage to decrease about 2% for the full year.

We also still anticipate gross new store openings of about 30 to 40 locations, which translate to 40 to 60 concepts.

Gross store closures are still expected to be about 120 locations or about 150 concepts.

Please turn to slide 11 for a discussion of depreciation and amortization.

Cash flow is an important metric for us.

In an effort to improve transparency of noncash items within our cash flow statement, starting this quarter the depreciation and amortization line will include the amortization of lease incentives.

This change is strictly a reclassification within cash flows from operating activities.

There is no impact to net cash flows, there is also no impact to our balance sheet or income statement.

Lease incentives are cash payments received from the landlord upon entering into certain store leases.

They are recognized and amoritized as income on a straightline basis over our average lease term.

Because the amortization is noncash income, it reduces the overall amortization expense.

Accordingly, we expect depreciation and amortization for 2003 to be in the mid to high $600 million range.

Deferred lease incentive amortization comprises the vast majority of the decrease to our prior guidance.

On slide 12, we provide a comparison of how the new classification changes the presentation within our cash flow statements for the first quarter last year and the full year reclassified depreciation and amoritization for 2002, 2001, and 2000.

Please turn to slide 13 for the calculation to determine the dilutive effect of our converted note on first quarter earnings per share.

To determine the delightive effect on convertible note on earnings per share, the note must be compared as debt and as equity.

Looking at the slide, the left hand column treats the column as debt.

Now let's walk through the right hand column, which treats the note as equity.

First, $12 million in after tax interest on the convertible note is added back to the first quarter net earnings of $202 million.

Second, $85.6 million convertible shares are added to our diluted share base of about 894 million shares in the first quarter.

This results in a total diluted total diluted share base of 980 million.

As you can see earnings per share is less when treating the note as equity than when treating the note as debt.

So the note has a dilutive effect for the first quarter.

In terms of knowing when our convertible note is dilutive, assuming our first quarter effective tax rate of 39%, the dilutive breakpoint is 14 cents per share in any quarter and 57 cents for the full year.

This completes my review of our financial performance.

In summary, having now been on the job for a full quarter, it is so clear to me the tremendous leverage we have when we focus on key performance levers.

Our first quarter results illustrate how quickly we can impact comp and margin.

As we continue to improve our product assortments, marketing, and customer service, we will focus our strategies on improving margins, increasing th efficiency of our capital resources, and strengthening our balance sheet.

Overall our performance in the first quarter reign forces my confidence in our abilities to execute against our strategies, sustain our turnaround, and earn our way back to growth.

At this time I would like to turn the call over to Paul.

Thanks, Byron, and good afternoon.

Of course we're very pleased with our first quarter earnings performance and continued turnaround momentum in our business.

This is our third consecutive quarter of positive comparable store sales and earnings growth.

Since our turnaround began last fall, stronger product assortments have driven continued improvement in merchandise margins, supported by more regular price selling and better markdown margins.

Our focus on service has resulted IP better conversion, helping to offset negative traffic and drive comp performance.

Customer feedback also is increasingly positive, and we're seeing more impact from our marketing efforts at Gap and Old Navy.

I'm extremely proud of what our teams are accomplishing.

We are still early in our turnaround and development of long-term strategies but we are clearly gaining traction as we work to sustain our performance and earn our way back to growth.

Companywide our priorities remain unchanged.

Improving product design and merchandising, gaining consumer insights, driving greater operating efficiencies and developing talent throughout our organization.

Today I want to give you brief update on progress at Old Navy, Banana Republic and Gap Internationals, and then Gary will provide a more detailed review of Gap before we take questions.

Old Navy had great success in first quarter against its key objectives, refining its brand positioning as a value player with a specialty flare, enhancing productivity of existing stores, and effectively merchandising and marketing to targeted customer segments.

Jenny and her team continue to drive healthy top and bottom line improvement.

Old Navy's focus on creating merchandise assortments using clearly defined product filters, customer segments helped drive strong results in most product categories.

Women's performed best.

In women's active, our graphic tops and swim wear were very strong.

In bottoms, Capris, skirts, were best sellers, knit tops were also very popular.

And our women's boot cut suported by advertising was a strong performer in denim.

For men, swim wear, woven shorts, denim and T's were strong performers.

Our baby business also did well with product segmentation by newborn, infant an toddler fully implemented this quarter.

Another highlight was maternity, which is significantly exceeding expectations and clearly adding incremental sales.

Maternity product is now in more than 50 stores in addition to on-line, rollout to another 30 stores is planned this fall.

Maternity is a good example of how Old Navy is introducing new product categories to better serve new and existing customers and improve store productivity.

On a marketing front, Old Navy's popular denim game TV campaign helped drive improvement in traffic and comp sales.

The marketing campaign reinforced Old Navy as a denim destination for the whole family, driving sales increases across all denim pants, with women's the strongest.

Our research shows the denim game scored well across all customer segments with the spots consistently cited as the most remembered ads of the quarter.

Old Navy sponsorship on American Idol has been highly effective in reaching younger customers.

A new TV campaign highlighting item of the week promotions and positioning Old Navy as a summer clothing destination broke last Thursday and runs through mid -June.

The campaign themed around Love Boat TV series features segmented spots fo younger customers and families.

Old Navy expanded its circular in the first quarter with broader and deeper market penetration in April.

Four additional markets were added for a total of 22, reaching about half of Old Navy's customer base.

This will be the new circulation base going forward.

For key holiday's such as Memorial Day, circulars will be distributed nationally.

The Memorial Day sale circular hits May 18th.

We're also in store with a tenth edition of popular and iconnic flag tee, always a fourth of July favorite for the whole family.

With our focus on developing and adding talent to the organization, we're excited Patty Johnson has joined Old Navy from Kohl's as Chief Financial Officer.

Patty will build on the work done by Lee Bird, promoted to Chief Operating Officer of Gap Brand.

Her experience in the value sector will be invaluable as Old Navy continues to strengthen its brand positioning against other valued players.

We also recently announced the promotion of Tom [INAUDIBLE] to Executive Vice President of stores for Old Navy.

Tom who joined us last fall from Target brings a strong value oriented retailing perspective to the brand.

Turning to Banana Republic, results were more mixed for the quarter, however we are seeing stronger customer response in categories where we clearly have a differentiated product offering with elevated quality, fabrication color style and detail.

For example, Banana Republic's women's full flounce skirt became a best seller.

In addition to skirts, women's blazers and accessories performed well in the first quarter.

The men's business continues to be a challenge.

Men's pants was weakest with better performance in outer wear and knits.

The brand is focused on introducing more newness and competitively distinct products in men's assortment as we move forward.

Spring marketing was less effective than anticipated in driving traffic.

However a segmented direct sale campaign targeting loyal customer and a bounce back coupon were successful.

Banana Republic is focused on three priorities.

First, differentiating product through elevated fit, quality, and fashion.

Second, effectively segmenting marketing and creating a stronger emotional connection with customers.

And third delivering more elevated customer service levels and a better in store shopping experience.

With Maureen's [INAUDIBLE] decision to leave the company we first are considering internal candidates before looking outside the company for a new Brand President.

We're committed to finding someone with strong merchandising and retail apparel experience.

Meanwhile the brand has a talented team in place.

Deborah Lloyd, Banana Republic's head of design and her team continues to lead strong product improvements particularly for women.

The brand also is developing clear product filter to ensure balanced assortments with products that have emotional and aspirational appeal.

Merchandising led by Julie Rossen is working closely with design to deliver balanced product assortments to targeted customer segements.

Jack Calhoun joined the brand at the head of the quarter for marketing.

We clearly need to improve marketing effectiveness, and help differentiate the brand.

Jack and his team are evaluating the most effective marketing mix to enhance brand image and to drive traffic.

Steve Stickle who recently moved to Banana Republic from our outlet division of head of stores and operation is leading efforts to elevate the customer experience.

Steve who has more than 20 years of retail merchandising and store operations experience joined us in January, 2002.

As we elevate product and marketing, we must also elevate customer service.

For example, Banana Republic is bringing back its client service program this fall to top stores with a rollout plan for all stores in 2004.

The program re-introduces client specialist to specifically serve Banana Republic's best customers.

With the focus on these three priorities we remain confident Banana Republic's strategic production and ability to create a unique position in the marketplace.

Turning to Gap International.

We're very pleased with the first quarter performance.

International has posted eight consecutive months of positive comps.

Spring product performed well in all markets compared to last year.

Our women's business was particularly strong in Japan where introduced more country specific product better tailored to customer needs.

For example, five of our top 15 women's products in first quarter were fit designed specifically for Japanese customers.

Across the business increased conversion, higher units per transaction help offset negative transaction.

As in the U.S., we saw a positive response to marketing and offers.

Gary will update you on the progress in the U.S.

Good afternoon.

Our goal of Gap in the first quarter was further the stabilization and build on the progress we began to see in the fourth quarter.

We were pleased with results in Q1 which reflected continued progress at 2003 priorities.

We continue to refine our product in terms of style, color, mix of assortment t reflect what our customers want from Gap brand.

Our focus on in-depth customer research to help us continue to identify customer profiles and behaviors.

For example, spring the first time we segmented by gender, a strategy that drove improvement in traffic trends and strong sale through specific items.

Additionally programs to improve in store experience have developed attraction.

Further we've made key additions to senior management, all of whom serve to strengthen our brands commitment to the customer and position us well for continued improvement.

Now let me take you through each of these points I've just mentioned in mor detail.

In the first quarter we continued to improve our product and assortments.

We offered iconnic Gap items bringing back a strong fashion sense ability that clearly resonated with our customers.

We interpreted color in a way that generated excitement and led to several outstanding product successes.

For example the pink Mack for spring and Tunick were must have.

Poll os were a color-driven success in the quarter.

We also approachedmen and quarter differently for the quarter offering unique pallets by gender.

We work to create product quality with woven and khaki pants by construction in detail.

For the first time we began to communicate our two women to customers through underpants and in store signage.

Both outperformed expectation and got great feedback from customer.

Women's bottom business continues to perform strong with capris the highlights of the quarter.

In the third quarter we're re-launching men's denim as well as kids denim and calc is. khakis.

Spring campaign was the first time we segmented marketing by gender.

Stretch pants to women.

We startinged men through print, as well as in store try on your pants promotion, highlighted men's products.

We saw not only an improvement in traffic trends during the TV campaign but strong conversion which we were pleased with the performance of both women's stretch pants and men's khakis.

We have a program that will feature gender specific products through direct mail and store promotions.

We'll begin TV in the fall.

Gender presentation is a step to use marketing to target direct customer segments.

We have several initiatives under way to help us create an informed long-term vision on how we will serve markets.

We have been working with Lee on market segmentation.

We're continuing to gather results.

We have work to do to understand our customer from a lifestyle point of view.

We're excite about the insights the Burnet research should provide.

We are also looking to harness the vast amount of information our store employees have about respective customers and markets.

This month we launched a store manager feedback loop in which they complete a survey each quarter.

We're able to gather data, prof files, seasonal opportunities for assortments and customer satisfaction levels.

While we're pleased with the improvements we're commit with finding new ways to consistently enhance the shopping experience.

Last fall we introduced the conversion program and have just finished rolling it out to all subprograms.

It's to improve store processes and provide fundamental to store associates.

It's helped to drive the increase in conversion we have seen over the past two quarters, also resulted in better replenishment, fitting room and cash experience.

In the area of talent I am thrilled with several recent additions to Gap senior management team all of whom I believe bring a strong customer focus to the organization.

As you know, Lee Bird joined Gap as CEO from Old Navy overseeing strategy finance and operations.

During his tenure we championed several initiatives he should apply at Gap.

He headed a markdown at Old Navy which will begin to roll out in Gap this summer.

Additionally Lee made significant strides to increase store accountability aroun payroll.

I'm excited to have Lee on board as we move the brand forward.

We announce we've hired two new talented designers, Peter, Senior Vice President of design and product development, and vice president of women's design.

Both bring a strong appreciation for the customer and should help further the product successes we are seeing.

Regarding the head of marketing the search continues and filling this job remains my top priority.

In the meantime the Gapped marketing team has done an excellent job in creating memorable and exciting campaigns.

In the first quarter we accomplished what we set out to do.

The Gap brand is evolving and I am very confident we're on the right track to propel the brand forward.

In the second half we will learn and build on the successes we are seeing, and leverage the lessons, and continue to refine the product mix actively re-engage the customer and further our market segmentation efforts.

That concludes prepared remarks.

We will open up the call to questions.

We would appreciate it if each caller would limit their questions to no more than one.

In order to ask a question, please press star one on your telephone keypad.

We'll pause for just a moment toss compile the Q&A roster.

Your first question comes from Kindra Devaney of Fulcrum Global Partners.

Hi, thank you.

My question centers on inventory.

First of all, Byron, it looks like the inventory number you reported for last year is about 130 million than what was in the actual quarter, I wondered if it was a change in the statement or how you're accounting for that.

Secondly can you talk about implementing an inventory system that's not goin overly well or tell me what's happening in that.

Someone in the store told me there was changes in how you're accounting for your inventory.

Let me take the inventory guidance we gave was about 15% increased in our inventory levels.

We cain at roughly 17%, pretty close.

In terms of the absolute increase we're a little over 300 million of increase, and I'm looking to my colleagues here.

I think we did a restatement of inventory levels.

This is Sabrina.

I'm wondering if you're referring to an old 10-Q, perhaps.

Because if you remember as of the end of our third quarter last year, we had the shift in inventory and accounts payable where both of the numbers were grossed up, and we went back and re-set the inventory level.

Sounds like you must be looking at an old number.

Because the number we just reported at May 4th, 2002 was $1.792 against $2.1 billion.

That was the re-stated number.

Yeah.

Okay.

Great.

And then your systems that you're changing?

We are in the midst of in the midst of the changeout of our inventory system.

We have selected the retech inventory module to implement here.

That's under way.

We expect that to take the better part of two years to completely implement, but that is under way.

And is that causing any disruptions in your inventory flo?

No, because we're still in design mode for that particular system it is at least a year and a half away from going into pilot, so we're still using the existing legacy inventory syst.

Okay.

Great.

Thak you.

Your next question comes from Lauren Levitan of SG Cowen.

Good afternoon.

Byron, I was hoping you could give us some greater explanation of how you will be making real estate decisions going forward.

I know you haven't given guidance of what the '04 real estate plan might look like.

I was hoping you could give us some sense of what type of return characteristics you would be looking for for new store openings and assessing the leases that are up for review upon expiration.

Thanks very much.

I'd be happy to.

Prior to my arrival, the finance teams had and real estate teams had implemented a tool which allows us in a much more sophisticated way analyze the returns of our store from a canniballization standpoint market by market.

So with the 4 to 500 lease action that is we have naturally recurring each year, we are using that as an opportunity to apply those tools.

We actually do a return on investment calculation for each leased, whether it's a new one or whether it's a lease to be renewed.

In the calculation of that return on investment, we actually take the operating lease and we treat it as if it were a capital lease.

And based upon the internal rate of return, in order to green light either a renewal or a new store, we look for a return that is a meaningful increment above our cost to capital.

And that's the approach we use.

And can you give us some sense as to what the preliminary review of that 4 to 500 for this year might look li?

If you take a look on page 5 of the annual report, you will have a pretty good indication of what we're expecting in 2003 with regards to closures we're about 120 for the year.

Now, that's gross closures.

We expect to open 30 to 40 new stores, which would offset those closures.

Right.

But looking forward can give us some estimate of how many stores are performing at a level which would be below that total rate that you're now applyi?

We're not currently giving that level of guidance.

But as the year progresses, we will give you an outlook for how 2004 will be shaping up.

Great.

Thanks .

Your next question comes from Mark Friedman of Merrill Lynch.

Thank you.

Good afternoon everybody, great job in the quarter.

Paul, both you and Byron mention the phrase, "earn our way back to growth."

I was wondering if you could talk a little bit about that.

You're three-quarters into a strong recovery here.

At what point do you think you've earned your way back to growth.

If you could give us any in site as to things you're thinking about as to what that growth might be in the future.

Thank you.

I expect you'll tell me when I've earned the right back to growth.

We're still very focused on the turnaround.

Of course we are pleased on what we've accomplished so far.

We think there's tremendous opportunity to optimize the business yet, tremendous amount of leverage.

Everything from optimizing our inventories to selling more goods at regular price.

We think there's plenty of opportunity.

Having said that, we will start to look at growth opportunities in the future and as I mentioned before, I think those growth opportunities, some of which you're seeing today, as it relates to new categories that we're adding within businesses, whether it be maternity, Old Navy and Gap, petite sizes we've launched on line at Banana Republic and hope to do in our stores in the fall.

Category growth is a opportunity for us.

Clearly we think with Old Navy there's still real estate opportunities domestically, to a lesser degree, Banana Republic, Gap, a strong belief in our body business and kids and baby.

So there is some brand real estate opportunities as well.

Then longer term, as I've talked, international is definitely something we've continued to focus on and are studying.

I've also said we want to make sure we're doing it profitably with appropriate returns on capital.

Ultimately we will be looking at new brands and acquisitions.

That's the comment.

I want to emphasize we still think there's tremendous opportunity to get back it our historical margins and improve the efficiency of the business.

Thank you.

Your next question comes from Kimberly Greenberger of Lehman Brothers.

Thank you.

Good afternoon.

Congratulations on a terrific quarter.

I was wondering if you could talk about your traffic trends in the first quarter, either if you have them by brand or by the company consolidated?

Secondarily, if you could talk about your SG&A dollar growth you're anticipating in the second half of the year.

Third, Byron -- I mean, Paul, if you could update us on the talent search you identified you were focusing on specifically in marketing, on line and international, that would be great.

This is Byron.

Let me go first with SG&A.

I think you may know we have divided this year, this turnaround year into two six-month budgeting seasons.

And so we will be completing the second half budget by late July.

And shortly thereafter we will be prepared to give guidance on SG&A for the second half of the year.

And I'll start on the traffic piece and then talk about talent.

Just to give you an idea, I can give you some numbers on Gap for February of '03 our traffic was down 11.9%.

March was down 11.9%, then April was down 2.2%.

In Old Navy, February was 10.9% down, March was negative 6.4, then April was a positive 1.7.

Let me just kind of talk about that briefly for a second, is that we are still challenged on our traffic count, but we are doing two things, certainly focusing on our conversion within the store, which is absolutely helping the overall comps of the business, and we think conversion programs particularly in Gap is very successful.

Our customer engagement programs which are the second phase of our service module are being rolled out at Gap and Banana Republic as we speak, and we feel good about that.

Also our marketing effectiveness, we know that we need to in some cases improve and in some cases we're getting the atrack we expect.

I also want to say it's the quality of the traffic.

We know in Old Navy we were able to bring families, a significantly greater number of families who may shop less frequently but shop and buy more.

As much as the numbers are absolutely a metric we follow as relates to marketing and marketing effectiveness the quality of the traffic is equally important to us in how we're converting them.

Then as it relates to talent, we are continuing to as Gary mentions we are ver focused on filling the market position, we think we're getting increasingly closer to that particularly as it relates to Gap and Old Navy.

Banana Republic, Jack Calhoun came in for that job.

International is still a search, we're considering internal candidates for Banana Republic before I make a decision to go outside or not.

We've got good attraction with the addition of Patti and others.

We're making progress.

Paul, how refeeling about beverage strength, can you give us some context to understand some of the recent departures you've had, obviously marine and Michelle, for examp?

Honestly, I feel very good about our beverage strength.

We have a bench strength.

We have a tremendous amount of talent.

As I said all along, we definitely think there's opportunities for us to improve and bring in new talents and new perspectives.

I'm not too concerned.

It was unforth na marine left us, we know it was as much a personal decision for her, her family and getting her husband back to France.

We understand that.

Chanel is an interest opportunity and I understand that.

Michelle left two years ago and went and got married.

I can't have control over that.

I feel very good.

We have a great tall ended group here and everybody is based on their results and successes.

Thank you.

Your next question comes from Jeff Klinefelter of U.S.

Bancorp Piper Jaffray.

yes.

A question about the inventory with respect to deflationary pressure.

We're hearing about a lot of retailers particularly those in the value channel talk about at least a sort of situational deflation here at Q2.

Can you talk about obviously not hitting your pricing at retail at this point.

Can you talk about how that may or may not be impacting you and any sort of updates on the sourcing side of your business?

Specifically with respect to the SARS issue in China and Hong Kong, but maybe anything else around your global sourcing network as well.

Thank you.

For the most part we have not really seen any affect in this inflationary environment we're not seeing any major changes in IMU's or pricing strategy at all.

On our sourcing side, our scale really becomes a competitive advantage for us, because we're able to leverage strongly against that under base.

And we are seeing sourcing savings in this environment, which is certainly helping us.

As it relates to SARS, obviously it's been very -- something we've been watching very carefully.

We have restricted some of the travel, you know, that's not mission critical for our sales associates here, not to travel.

Having said that, we are not as reliant on the need to travel to the orient.

We have some 20 offices around the world.

We source in over 50 countries as you know.

Only about 14% of our merchandise comes out of China specifically.

And I think we're all a little bit encouraged by some of the down trending in some of the SARS issues most recently.

So it hasn't affected us to date.

We suspect the environment will get better.

As I said, we have people on the ground who live in these marketplaces, who are traveling to marketplaces isn't as critical.

And even if it were to increase in terms of the number of SARS cases, we have plenty of flexibility in our sourcing strategy retail to move our goods around.

Next question comes from [Jeanette of JJK Research].

Hi, everybody.

Congratulations on a nice quarter.

I was wondering if you could discuss your promotional strategy going forward.

It seems that the Old Navy advertising coming up will be focused on items of the week, and I'm wondering if you intend on getting more price oriented as we go forward.

Byron you mid a comment about the inventories coming out of the quarter that they seemed or were a little higher than expected.

Sounds like it wasn't residual product from Q1, so if you could identify the area where it is a little bit higher for me, that would be terrific.

Thanks.

I'll start on Old Navy, just real quickly.

We feel very confident with our marketing plan to date and what we have planned going into back to school.

Our television levels and all of our activities will be comparable to last year, in fact, in Old Navy's case slightly more increase as I discussed earlier in terms of the number of circulars that we're dropping.

We're very aggressive in using promotion within Old Navy to really drive traffic, and we've also got a great dynamic trying to learn about how much promotion and what's needed.

And the circulars have been helping us really drive more specifically in a market by market situation.

We also will be planning stockup sale in July as part of our promotions for Old Navy.

And Gary, I'll let you talk to Gap.

For Gap it's really about using our promotions more strategically.

We used to promote with markdowns and product offering great value prices.

Now we're doing a combination of things.

We're using, , you know, values on products.

For example, this week we have a promotion 25% off on shorts and T's we feel are more revanity to consumers at time.

We'll have a Father's Day promotion.

We're doing things with bounceback or summer pass program where if you spend $75 on a purchase between now and May, you're ed to come back in and get percentage off purchases in June, July, and August.

We're trying to be a little bit more unique and not just rely on product promotions.

Gary, on the 25% off product on shorts and tees does the price go up after the promo is over.

Yes, the price goes back up.

How many days?

The promo runs through I believe next Wednesday and the prices go back up.

Okay.

Thanks, Gary.

So be sure and get in by next Wednesday.

Don't worry.

So with regards to inventory, we are a couple of points higher, and it is mostly summer, so it is very current merchandising.

As I said before, as we finish the quarter compared to this quarter last year, we have less spring and less inventory at markdown.

So we're very confident in the quality of the inventory going forward into the second quarter.

But it should be up to a lower degree going into the third quart?

Yes.

We're guiding to roughly mid single digits.

Okay.

And then on the gross margin, which came in at a very powerful rate for this quarter just reported, as we go forward, Byron, and you come up against tougher compares on the gross margin line, can you give us an idea of what kind of increases we should expe?

I think you know we don't guide to margins at this point.

Would you guide us to be more conservative going forward?

That would be guidance, and we don't do that.

Thanks very much.

Your next question comes from Brian Tunick of JP Morgan.

Hi, good afternoon.

The question really is about the fashion cycle.

We've clearly seen it speeding up Gap being the largest retailer.

Can you talk about the opportunities shall opportunities shrinking lead times.

Right now we're looking at ways we can absolutely shrink our whole product life cycle.

The goal is to become much more competitive.

We are doing things to, you know, bringing things closer to market.

There are some initiatives in denim, working very, very closely with our vendor base not only for initial distribution but re-orders on chase and partner goods.

We've partnered to bring them in to help us since they are the experts around process design.

Okay.

So how many weeks traditionally do your back to school floor sets take to produce, and what do you think the opportunities are to cut several weeks out of that?

Really our challenge think is not around production, producing the garments, really around design inception through the production cycle.

We know who to produce goods, our production capabilities are very, very competitive out there.

It's really around development.

Okay.

Thanks very much.

Your next question comes from Stacy Pak of Prudential.

Thanks.

You know, I haven't seen anything like that seasons pass promotion you have going on in the Gap stores before, and I was wondering if you would comment on its effectiveness.

And you've given some of this, but could you clarify by brand the TV dates, the number of circulars, planned promotions, and flow dates on the merchandise at least for Q2.

If you can do Q3, that would be great.

Then, Paul, I was wondering if you would give your perspective on what you see going on with the consumer.

Do you see the consumer rolling over or picking up?

And if you want to comment, , you know, on comps months to date or just sort of what you're seeing, that would be great.

Stacy, I'll start out by just naming off some of the Q2 this year last year, if you want.

For Old Navy we talked about TV is four weeks this year versus four weeks network last year.

They had a couple more weeks on table last year, but those were pretty small markets, so I wouldn't think of those as very significant.

With regard to the old circulars at Old Navy, they have three drop last year.

They are going to have four drops this year.

Importantly two of those are going to be national.

So that's, you know, obviously a lot stronger.

Last year this year direct mail is about the same.

And then this year at Old Navy we have some more promotions going on.

Paul already mentioned the stockup sale, which is going to be new in July.

And we have a scratcher and a boundback coupon at Old Navy this year where we just had a scratcher last year.

Again, as Paul mentioned, incrementally more going on at Old Navy.

If you want to talk about flows for a minute, if you're talking back to school flows, they are going to come in end of July for Old Navy and Gap.

More gradually during July for Old Navy, end of July for Gap, and mid August for Banana Republic.

And are you going to do the marketing for --

you want me to do -- yeah.

Banana is about the same last year this year, more magazines.

We have much more magazine this year, Q2, we had none last year.

We have about the same, a little bit more newspaper going on at banana this year, Q2, and about the same direct mail and about the same outdoor in terms of billboards.

But we do have a fun promo going on in New York City where we're decorating about 100 hot dog stands.

I don't know if any of you have seen that, but that's out there or will be out there soon.

That's about it for Banana.

Gary, do you want to talk to --

for Gap last year we basically had some print and we had TV.

The TV we did not see any incremental gains and decided to bring it back to spring.

Was that the reason, Gary, the shift in TV to Q1.

Historically we've been on TV for Q2, last year we made the decision not to and moved it to Q2.

We didn't see any incremental gains so we moved it back to Q1.

Last year was really a markdown strategy.

This year we're more strategic.

There's markdowns.

Promos I described with summer pass idea.

We're doing e-mail drives and things of that nature.

It has much more dimension than last year.

And what's the reaction been on the season's pass?

It's somewhat confusing in some ways but then again it looks like it could be really effective going forward here.

We just really rolled this out, and we haven't really analyzed the results yet.

Okay.

You'll have to restate that last question.

What are you seeing in terms of the consumer?

What's your perspective?

Do you think the consumer is rolling over?

Do you see any picku?

I guess the best way to answer that --

how do you read the traffic?

We are, as it relates to our businesses, obviously we're seeing you know, a tremendous amount of our customers coming back.

We see this obviously in the numbers and we see this in our research the numbers they tell us they like when they are seeing in the stores.

From Gap, Inc. perspective we're still very confident in bringing those customers back who we have traditionally had and to some degree we abandoned over the last few years.

As it relates to go forward, that's a crystal ball which is hard to indicate in a business as fickle as ours.

We believe the strategies we have in place have worked in the last two quarters and are going forward.

We have time for two more questions.

Okay.

Your next question comes from John Morris of Gerard Klauer Mattison & Company.

Thanks.

You know, on that point about the customers, I'm wondering if you have -- obviously you're doing a lot in the way of studying the demographics and understanding who the customer is.

Are you seeing in the last couple of months any change in the demographic of the customer in terms of age or any other descriptive way you can tell ?

Well, broadly speaking, you know, in a couple of areas, particularly for Old Navy, the answer is yes.

When we specifically went out ant targeted families and then specifically targeted teens, we absolute saw an increase in traffic on the families coming into Old Navy.

And Gary has seen the same thing as it relates to Gap brands.

So we're clearly seeing that a lot of our traditional customers, a little bit of an older age group, an specifically the targeted segments that we have been going after we've seen some improvements.

So it feels like it's getting a little bit broader as as a result of segmentation an focusing our marketing segments specifically on those segments.

In terms of I know we were talking about the inventory earlier and forgive me if I missed it, but the higher inventory level that you did see, is it pretty much evenly across all divisions or more skewed toward one division as opposed to another.

I would say it's reasonably spread over the divisions.

There's no particular callout.

Okay.

Thanks.

Your final question comes from Emme Kozloff of Sanford C. Bernstein & Company.

Hi, there, a question on the marketing strategy.

Is it different than what you've had in place, you're pleased with the markdown rate.

Have you changed it since taking over and how will you change it going forward ?

I think the one callout that would be different is at Old Navy where with what we're doing is looking at the number of promotions, the length of the promotions, and then, of course, the pricing as it relates to each one of thos promotions.

So we are seeing that we can get good traffic and good response and also be able to yield manage our margins in a way that can be more successful.

Old Navy also introduced and we had talked about profit logic, which is a software systemes piece that allows us to better yield manage markdowns so we have a more granular more sophisticated appraoch.

I think you know in the past what we did in the past is stair stepped our pricing, our markdown.

Now we're looking more dramatically at demand curves and understanding different price points and the timing of those price points.

Gary's team is in the process of implementing markdown optimization as we speak.

Great, thanks.

Great.

Well, I'd like to thank everyone for joining us on the call today.

As always, the investors relations team will be available after the call for further questions.

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