蓋璞 (GPS) 2005 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to Gap, Inc.'s third quarter conference call.

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Investor Relations at 1-415-427-2175.

I would now like to introduce your host, Sabrina Simmons, Senior Vice President of Treasury and Investor Relations.

Good afternoon, everyone.

I'd like to welcome you to Gap, Inc.'s third quarter 2005 earnings conference call.

For those of you participating in the webcast, please turn to slide 2.

I would like to remind you that the information made available on this webcast and conference call contains forward-looking statements, including but not limited to forecasts relating to earnings per share, operating margin, free cash flow, store openings and closings, net square footage, gross interest expense, inventory per square foot, capital expenditures, depreciation and amortization, effective tax rate, as well as other statements that express our expectations, anticipations, beliefs, estimates, intentions, plans and forecasts.

Because these forward-looking statements involve risks and uncertainties, there are important factors that could cause our actual results to differ materially from those in the forward-looking statements.

Information regarding factors that could cause results to differ can be find in our annual report on Form 10K for the fiscal year ended January 29th, 2005.

Investors should also consult our quarterly report on Form 10Q for the quarter ended July 30th, 2005, and today's press release.

Future economic and industry trends that could potentially impact net sales and profitability are difficult to predict.

These forward-looking statements are based on information as of November 17th, 2005, and we assume no obligation to publicly update or revise our forward-looking statements, even experience or future changes make it clear that any projected results expressed or implied therein will not be realized.

This presentation also includes a non-generally accepted accounting principal measure, free cash flow, which under SEC Reg G we are required to reconcile with GAAP.

The reconciliation of this measure to GAAP financial measures is included in our earnings press release, which is available on gapinc.com.

On today's call Byron Pollitt, our CFO, will cover our financial performance and guidance for the remainder of the year.

Following Byron, Paul Pressler, our CEO, will summarize third quarter performance.

After Paul, Cynthia Harriss, President of Gap brand, will discuss business.

And then Jenny Ming will discuss the Old Navy brand.

Following Jenny, Paul will make closing remarks, and then we will open the call up to questions.

We expect the call to last about 1 hour.

Now, I'd like to turn the call over to Byron.

Good afternoon.

Business in the third quarter remained challenging, and weak traffic across all 3 brands was the primary level resulting in negative comps.

First, I will take you through our results for the quarter, and then walk you through our guidance revisions.

Results for the third quarter can be summed up as follows: Net earnings declined 20 percent to $212 million, or $0.24 per share; gross margin declined 400 basis points.

We ended the quarter with 2.3 billion in total cash and investments.

We doubled our Q3 dividend to $0.045 cents per share, and we repurchased 10 million shares of stock during the quarter for $188 million, reducing our end of quarter shares outstanding to 872 million.

Since October of 2004, we have utilized $2.7 billion to repurchase 129 million shares.

For webcast participants, please turn to slide 3 on earnings performance.

Third quarter earnings were 212 million, or $0.24 per share, down $0.04 from last year.

Year-to-date earnings were 775 million, or $0.86 per share, up $0.05 from last year.

Please turn to slide 4 for sales performance.

Total sales for the third quarter declined 3 percent from last year, to 3.9 billion.

Consolidated comp store sales, down 7 percent.

Year-to-date total sales were down 1 percent, to 11.2 billion, and consolidated comp store sales decreased 5 percent.

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

Turning now to gross profit performance on slide 5.

During the quarter, we experienced significant pressure on gross margins, as unit velocity was less than expected and goods had to be promoted or marked down.

Gross margin was 35.3 percent for the quarter, down 400 basis points.

Merchandise margins were down 240 basis points, driven by disappointing customer response to fall product, and rod deleveraged 80 basis points.

The remaining 80 basis points of decrease, are due to a reclassification of sourcing costs, from SG&A to cost of goods sold.

A word of further explanation: We have been classifying the vast majority of our sourcing expenses to cost of goods sold.

However, some costs related to our agent offices had been classified to SG&A.

Upon closer examination, we believe it's appropriate that these expenses also be included in cost of goods sold.

This reclass, of about $30 million, moves year to date 2005 sourcing expenses originally included in SG&A for quarters 1 through 3 to cost of goods sold.

All of the costs impacted by this reclassification were previously expensed in the period incurred, and therefore this change has no impact on earnings.

Turning to operating expenses on slide 6.

Third quarter operating expenses were 1 billion, down 8 percent to last year.

The decrease was primarily driven by lower bonus accruals and marketing expenses, as well as the absence of premiums paid on early retirement of debt.

Also, please note SG&A in the third quarter benefits from the 1-time reclassification of $30 million in sourcing costs from SG&A to cost of goods sold.

Marketing expenses in third quarter were 152 million, down 9 percent, driven by lower spending on Gap television, and the reallocation of funds at Old Navy to enhance the store experience.

Year-to-date operating expenses totaled 3 billion.

Year-to-date marketing expenses were 387 million, about flat to last year.

Turning to inventory on slide 7.

We remained disciplined in our inventory management during the quarter.

We ended the third quarter with 2.5 billion in inventory, down 3 percent from last year.

Inventory per square foot was $64 at the end of third quarter, down 7 percent.

Please turn to slide 8 for more detail on capital expenditures and store count.

Year-to-date, capital expenditures were 448 million, driven by a higher number of new stores and remodels during the quarter, versus last year.

Year-to-date we have opened 180 store locations and closed 57.

We ended the quarter with 3,117 stores.

Please refer to the press release for end of quarter store locations, and square footage by division.

Please turn to slide 9 for more detail on free cash flow.

Year-to-date, free cash flow defined as cash from operations less capital expenditures was an outflow of 120 million, driven by higher capital expenditures associated with the opening of new stores.

Please refer to our third quarter press release for our Reg G reconciliation of free cash flow.

Total cash and investments were 2.3 billion at the end of the quarter, 1.8 billion more than funded debt.

Turning to slide 10, I would like to comment on our outlook for the remainder of 2005.

Since our last guidance update at our Q2 conference call, traffic has deteriorated at all 3 brands beyond what we originally contemplated.

Through the second week of November, Gap, Inc. traffic is down 8 percent and as a result, performance month to date is below expectation.

Factoring in a continuation of these trends, we are lowering guidance as follows: Earnings per share; we expect annual earnings per share for fiscal 2005 to be in the range of $1.12 to $1.17.

Operating margin; we expect operating margin to be 10 to 10.5 percent.

We expect free cash flow to be 800 million to 900 million.

Regarding store activity and square footage; we expect to open 195 store locations versus prior guidance of 190, driven by a shift in timing of Old Navy stores.

We expect to close 145 store locations, up from prior guidance of 140, driven by additional closures at Gap division.

We expect full year square footage to increase 3 percent.

We expect gross interest expense to be 50 million.

We expect inventory per square foot at the end of fourth quarter to be flat.

Inventory per square foot at the end of the first quarter of 2006 is expected to be down in the low single-digits.

We have not changed our 2005 guidance regarding capital spending, depreciation and amortization, and tax rate.

We expect full year capital expenditures of about $625 million, depreciation and amortization to be about $550 million, and an effective tax rate of 38 to 39 percent.

Now, I'll turn it over to Paul.

Thank you.

As Byron said, there has been no change in momentum following our disappointing fall results.

Month-to-date traffic trends continue to deteriorate even further than we anticipated, leading to our decision to lower guidance for the year.

Our third quarter performance is unacceptable.

Before discussing the actions we're taking to improve, I'd like to step back for a moment to provide a broader perspective on where we are in the business.

Over the past 2 years, we focused on building our infrastructure to support long-term growth.

While this work was critical, at times we drove operating efficiencies, at the expense of creating amazing product and compelling store experiences.

For example, in optimizing our supply chain processes, we overweighted our focus on generating cost savings.

Now, we're balancing that focus, with the innovation, quality and speed required to create covetable, trend-right product.

As a leadership team, we are 100 percent focused on the actions requires to improve our product and store experience.

Later in the call, you'll hear more details from Cynthia Harriss and Jenny Ming, but I'll start with an overview.

First and foremost, product.

The specific issues vary across brands, but overall we must improve our product offering.

Today, our designers and merchants are creatively aligned around their brand's product positioning, and clear on the changes required to be successful.

They feel a tremendous sense of urgency to create trend-right, brand appropriate product.

And our merchants are empowered to build assortments that reflect a strong point of view.

To help facilitate this, for example, at Gap and Old Navy, we are adjusting the way we development and assort some of our on-trend product.

In the past, we developed all of our product through the same 9-month pipeline, whether a basic tee or embellished tank top.

While we'll continue to use this process for the majority of our merchandise, designers and merchants will also work dynamically with vendors to create and deliver some of our product much faster.

This will allow us to chase trends in season, and more quickly react to customer response.

We believe that holiday assortments across all of our brands have improved.

However, as indicated by our guidance, we are not optimistic about the fourth quarter, recognizing that it will take time to win back some of the customers we have disappointed.

Winning back our customers requires that we clearly communicate the shifts in each brands' offering.

So our holiday marketing strategies are focused on driving traffic, with overt product and gifting messages.

Our plans include new innovative mediums, planned promotions, and compelling windows and visual presentations.

Cynthia and Jenny will talk more and Gap and Old Navy in a moment.

At Banana Republic, we're making it very clear to our customers that the brand is a gift destination.

This week, stores set gifting tables and clear signage to emphasize great gifts under $50, as well as beautiful, compelling window displays.

In addition to print advertising, this year we're adding a Thanksgiving spend more, save more promo event, which begins this Saturday.

Regarding store experience, we must provide great customer experience in every store, every day, particularly given the increasingly competitive environment.

We are not consistently providing the experience that our customers expect from our brands.

So our teams have taken several steps to ensure that we begin executing flawlessly.

First, we are streamlining store communications and simplifying processes, to free up store associates time to focus on our customers.

Second, we are allocating our holiday payroll dollars to ensure better service.

This includes adequately staffing our fitting rooms, cash wraps, and key item tables during peak hours.

And third, across all brands, we want to reclaim our authority in strong visual presentations that showcase our product and inspire our customers.

Gap has incorporated more impactful visual merchandising for holiday, and next year Old Navy is adding store visual management staff to support strong execution.

These are a few of the examples that reflect the direction we are heading in each of our businesses.

Now, I'll turn it over to Cynthia, and then Jenny, to share more details.

Thank you, Paul.

I have now been with Gap brand for about 6 months and my priority has been to spend all of my time with our teams, here at headquarters in San Francisco, in New York, and out in the field.

I have learned a great deal about the challenges the business has faced in the past, and the opportunities that lie ahead.

And most importantly, I have developed a strong point of view about what we must do to renew the iconic Gap brand, and to rebuild the health of our business.

The Gap team is committed to improving the business by refocusing on the fundamentals of retail; product, store experience, and marketing.

And although results have been disappointing, the team is taking action to improve our short-term performance this holiday, and to put us on the right path for sustained recovery in the long term.

So let's begin by talking about the product.

Over the last couple of years as we pursued occasions, we lost sight of delivering the essential Gap favorites in our assortments.

Those products, and the iconic Gap esthetic and colors, that our customers have depended on us to deliver.

To be successful in the future, we must have a clear point of view on the key items Gap will be famous for, to deliver our fresh, casual, American style; always, and for each season.

Our customers rely on Gap to interpret trends in the Gap way,and to deliver product that is fresh, compelling, of great quality, and with a comfortable, reliable fit.

Delivering great product will require strong leadership.

I'm very pleased that Charlotte Neuville joined the Gap team on October 17th, to lead design and product development for our adult business.

Charlotte brings more than 20 years of design experience and exceptional leadership and management skills.

Her clear and confident way of working has energized and focused the team.

She also has a strong and proven ability to interpret style, and to provide leadership and product development.

Charlotte lead New York & Company's design team for apparel, and she's held the senior design positions at several premier apparel brands.

Through her extensive relationships in the design community, Charlotte has already infused new perspective and expertise in many areas, including color and product R&D.

Although Charlotte's influence on the product won't be evident until late in 2006, we have made progress with Holiday '05.

This is the first season that signals our return to the fresh, casual American style product filter and esthetic.

You'll see a move to the bright, optimistic colors Gap is famous for, leaving behind the muted colors of 2004.

And you'll see that we're refining the assortments, offering fewer programs, with a wider range of color offerings.

Our signature pocket tee lambswool sweater, our waffle henley, and our warmest vest, are great examples of brand-right product.

You can count on seeing more signature Gap items every season.

While we're pleased with the progress we're making with the product, there is still work to be done.

We have disappointed our customer for several seasons, and we know it will take us time to win them back.

The second retail fundamental we're focused on is the store experience.

I'm very pleased that Mike Griggs joins Gap brand to lead the store's team.

Since his arrival in mid-September, Mike has spent all of his time with the field leaders, reinforcing the elements of executional excellence, and inspiring the people.

Mike is respected and valued as an expert field and merchant leader, with a broad diversity of retail experience.

He has worked with me for over 20 years; first at Paul Harris, later at Disney, and most recently, here at Gap Outlet.

I have great confidence in Mike.

He loves this business and he has a successful track record of reinvigorating stores, with both dramatic visual presentation and exceptional customer experience.

And critical to our business, he's an effective and inspiring teacher.

We're working to strengthen our in-store visual merchandising and product-focused service, better utilizing payroll to set the store, and to provide coverage that will bring our product to life, and engage the customer in the sale.

Furthermore, we realize our stores need to be updated.

And I'm sure most of you have seen our remodels in Denver, San Diego, and Hartford, as well as select stores, such as 59th and Lex (ph) in New York City.

In order to approach the remodels in a fiscally responsible manner, we will prioritize and address our most productive adult stores first.

The remodels will include those features that most directly impact our customers, such as lighting, music, flooring, and fixtures.

Finally, let's turn to marketing.

This holiday, our marketing strategies are intended to move us closer to the customer.

Our windows are designed to inspire our customers through dramatic presentations of our key items that should drive traffic.

They will be refreshed frequently throughout the season, gradually building on the holiday gifting theme.

Our holiday magalog, a hybrid catalog magazine insert, features great gifting ideas.

The magalog will be directly distributed to our credit card customers, and widely distributed through lifestyle magazines and partnerships with Borders Bookstores and Kodak.

These images will be used in color circulars and selected newspapers, as well.

Our goal is too create consistent messaging across our marketing vehicles, including in-store visuals.

Although we believe we're moving in the right direction as we enter this holiday season, there's more work to be done.

We are confident that we are on the right track with our product, and in the coming seasons, you'll see a more complete assortment of great product in the iconic Gap esthetic.

The key to our success will be continuing to strengthen the leadership of our business.

With strong merchant leaders, we have deep retail apparel experience and exude the energy and passion to deliver results.

In addition to Charlotte and Mike, last week we announced that Pam Wallack has joined Gap to lead Kids baby and maternity business.

Pam brings deep merchant and leadership skills, with over 20 years of experience in retail apparel.

Most recently, Pam delivered strong results as SVP and General Merchandise Manager for the juvenile and apparel business at Toys R Us and Babies R Us.

I'm so pleased to have Pam on the Gap team.

As a leadership team, we know that we need to make bold moves to achieve a healthy business.

We are serious about diagnosing the underlying causes of our business challenges, and we are disciplined about pursuing only those strategies and tactics that we have confidence we can execute well.

I'm confident that we will be successful in renewing the strength of the iconic Gap brand, and regaining our position as a leader in specialty retail.

Thank you.

So, now I'll turn it over to Jenny.

Thanks, Cynthia.

Good afternoon.

On today's call, I'm going discuss Old Navy's current performance.

Then I will share with you what we're doing going forward for Holiday.

At Old Navy, we have a distinct business model, a hybrid between specialty and value.

And we are at our best when we offer customers a unique combination of specialty product, with a strong value proposition.

And during the past couple of seasons, we focused too much on the value side of the equation.

And in doing so, our product assortment became too basic.

We need to strike the right balance between basic and on-trend pieces that customers expect from Old Navy.

Our customers have told us that our stores feel cluttered and difficult to shop.

The increase in the number of units in our stores and our drive for greater payroll productivity, hurt our customer experience.

As a result, our traffic suffered during the quarter.

Going forward, we're working on rebalancing our specialty and value proposition around product, marketing, and store experience.

We have started to make progress this Holiday, but there is still more work to do in the upcoming season.

Here is what we're doing for Holiday.

I'll start with product.

Though our holiday product is largely bought, there were areas where we were able to make changes to ensure that we have more on-trend pieces.

A Special Edition Denim is a great example.

It turns out demand for this product is higher than we originally planned.

Therefore, we took out denim fabric, and changed it with better washes, studs and more embroidery.

It's an elevated fashion item at a higher price.

And we'll be rolling out some styles of Special Edition Denim to all stores in our second Holiday flow.

And we believe that we have improved our balance of on-trend product for Holiday.

And we are confident that we have priced goods with compelling initial price points.

We feel good about our key item fashion pieces.

Boy-cut denim jeans, fashion sweaters and outerwear and all knits, especially T-shirts embellished with glitter and sparkle for the Holiday Season.

Our Holiday lines have more on-trend items than we have had in fall, and our second and largest Holiday flow is hitting stores now.

While we are pleased with our progress, we are cautious, given our recent trends through the third quarter.

The second area where we are making changes is marketing.

In marketing, we have adjusted our holiday TV spot to really highlight the product, and many of you have already seen our first Holiday TV add.

It focuses on boy-cut jeans.

We moved this ad up 1 week earlier this year, and our overall campaign will be on TV 1 week longer.

Our Holiday TV includes 4 national spots, each one is product focused.

And the next one debuts just before Black Friday, and we're using this TV spot to drive traffic into the stores.

Black Friday is going to be more of an event in our store with entertaining activities.

Black Friday scratcher games, great treats, and associates dressed like elves, to help customer find gifts.

In addition to the TV campaign and in-store promotion, our marketing mix includes a teen print campaign and circulars.

We increased the number of Holiday circulars this year, by moving one from January up before the Holiday.

And the last area I want to touch on, is of store experience.

We are investing more in the store experience for our customers.

We have made several changes right away.

First, staffing.

We added staff to replenish goods on the floor, and we are improving staffing at the cash wrap, to reduce the time customers wait in line.

Second, we're reducing clutter, including signage.

In our stores, it's making it easier for our customer to see our product.

In conclusion, we have a great team of talented people focused on moving our business in the right direction.

We are committed to fixing our product, and getting behind the right balance of on-trend items, making a stronger connection with our customer through marketing promotions and campaigns, and improving the store experience for our customer's satisfaction.

I am confident that we are making the right changes to drive our long-term success, but I know that it will take some time to get us all the way there.

So thank you.

Now I want to turn it back to Paul.

As you heard from both Jenny and Cynthia, our number 1 priority is improving our product, supported by effective marketing and compelling store experiences.

And while our year-to-date results are unacceptable, we are energized by the fact that the issues we face today are fixable.

And our teams are focused on aggressively taking actions to improve.

We are making progress in the near term.

But it will take more time before we see meaningful improvements reflected in our results.

When these actions take hold, we will have tremendous leverage from the strong foundation we've built over the past 3 years.

To deliver value for our shareholders.

Now, we'd be happy to answer your questions.

And that concludes our prepared remarks, and we're opening up the call to questions.

[OPERATOR INSTRUCTIONS] Emme Kozloff , Sanford Bernstein.

I have got 2 questions.

First, regarding the traffic issues, do you think that you made the right move for going Holiday television advertising for the Gap division?

And secondly, in terms of product at the Gap division, you've called your merchandising strategy "fresh, casual American style" or iconic Gap for over a year now, and it hasn't worked.

And on today's call, you mentioned the need for bright color in core items.

Yet, you did have a focus on color last year and core items at different points this year.

I don't mean to sound harsh, but I'm just confused about what is really new here.

Can you help me out?

Thanks.

This is Cynthia.

Responding about television.

What we know is, over the past several years, television has actually not driven traffic into our stores.

And in fact this year, with the fact that we have focused our television flights in our key top markets, we have the juxtapose between TV in stores, and not -- and have not seen a significant drive with the television.

Consequently, that data has really reinforced our position with the marketing strategy that we have taken, where we can talk directly to our customers with our magalog.

And putting a focus against the traffic that's in the mall with our strong execution of our windows.

About the the product, all I will say is that, really, this Holiday is the first time that we have used the filter of fresh, casual American style.

You have probably heard us talk about it in the past.

But this is the first time it really shows up.

And I think you can see it in the store with the color pallet, as well as the key item focus.

And we believe this is right for right now.

Okay.

Just quickly, given Old Navy's run negative comp for over 5 quarters, are you reconsidering square footage growth for the division in 2006?

This is Byron.

No, we're not.

The business model for Old Navy is rock solid, and even with the challenges we have had on the top line over the past several quarters, the returns on the Old Navy business model are excellent.

And with every new store that we consider putting into the fleet, we fully burden it with any cannibalization that might occur in the markets in which we're located.

So we feel very good and very solid around the store unit growth plan for Old Navy, and do not intend to take the foot off of the accelerator.

Okay.

Thanks, and good luck.

Dorothy Lakner, CIBC World Markets.

Yes.

In just looking at the improvements that you are trying to make across the products and the brands, how can you be confident that you are making progress?

Because I think I have heard both Cynthia and Jenny talk about the progress when you're not really seeing it yet.

Do you think you're speaking too early?

Do you think business could pick up?

Just help me out in terms of why you think there has been progress made and why you are not seeing any kind of -- any kind of pickup just yet?

Are there signs, for example, on some of the items that Cynthia mentioned -- the pocket sweater, et cetera.

Are any of those items gaining some traction that would lead you to have that kind of confidence?

Secondly, I think for Byron, everyone's also been talking about improving the store experience, and -- meaning more -- more people on the floor, I think to help out customers.

Does that mean that we're going to see some pick -- pick up again in SG&A in order to fund that effort?

Thanks.

Okay.

So this is Paul, and let me start.

I just want to ground the whole piece first, by saying that, we have -- we feel like we have made some significant improvement in our holiday assortments.

And as you have heard from Jenny and Cynthia, we feel very good about our focus on gifting and having the appropriate marketing messages.

But our change in guidance really reflects the deterioration that we have seen in our traffic -- specifically in the first 2 weeks of November.

So we are trying to be as transparent and realistic with regard to the fourth quarter, under the assumption that the traffic deterioration continues, as we have seen in the past.

Having said that, as we have talked about in the second half of this year, several strategies were deployed.

Some of which we believe we're seeing some lights of success, and in other cases, strategically we have made some errors.

With regard to Banana Republic, we are seeing some traction in the essentials, that we have really reassorted our products to be more focused on essentials.

Frankly, we wish we would have done more.

And as Jenny indicated, we may have overweighted in our value proposition for our customers, and that too will be corrected as we move forward.

And as Cynthia said, a lot of the fresh, casual American style is really just delivering right now.

So it is just too early to tell.

But we have taken a cautious point of view, given where we are with our traffic trends today.

With regards to SG&A, we -- you should not expect to see a significant increase in SG&A, as it relates to store labor.

Our approach to managing SG&A responsibly, is to first seek trade outs, and to reallocate more of our SG&A dollars into store labor and the customer experience, where we expect it to have a pay off.

And then as the revenue materializes, we would expect to see our operating labor leverage.

Great.

Thank you.

Mark Friedman, Merrill Lynch.

Thank you.

Good afternoon, everybody.

Paul, could you talk about beyond Christmas, where you stand as far as having the different teams implement some of the product for spring?

What is left, from a commitment standpoint, that you can make the changes?

Or is this further beyond, where the reality is, it's more fall '06 story, where you can have real significant change, especially within the Gap brand.

Thank you.

Thanks, Mark.

Needless to say, that every season we get a score card.

And every season, we attempt to make the course corrections and adjustments that we need to be successful.

So, the teams are very focused on making those changes.

Some of the things were enacted for the fourth quarter, that came in later than what we had originally planned earlier in our pipeline.

Having said that, we are very focused on trying to hold back some of our open-to-buy dollars, so that we can react more quickly as the seasons progress, both to chase those products that were successful, but more importantly, is to be able to be trend-right, by going after our product.

So as I said in the speech, we typically have used a 9-month pipeline to create all of our product, particularly at Gap and Old Navy.

Both Jenny and Cynthia are very focused on saying, how do we get the best product today?

And that's going to come from a more dynamic relationship between our vendors and our merchants and our designers, and we're starting to see that.

So course correction has been taking place.

We've reworked some of our spring and summer product, both at Gap and Old Navy.

And we'll continue to use this dynamic process for us to be more trend-right.

Lauren Levitan , SG Cowen.

Thanks, good afternoon.

You talked about how possibly some distraction was created through some of the internal infrastructure initiatives you had underway over the last couple of years.

I'm curious if you could talk about how you currently balance the needs of the core brands to get back on brand and get product in line to restore growth.

How you would balance that with some of the growth initiatives you have announced, and any others that you have underway in the Company.

Thanks very much.

Thanks, Lauren.

It's Paul again.

I'll answer that.

One, I just want to -- you know, this past couple of years, there were a couple of significant things that we felt were critical to building a healthier company and then, most importantly, building a longer-term growth platform.

We have done a lot of work, as you know, around building our disciplines in inventory management.

That comes from also being able to manage it in season, as well as preseason.

Our Consumer Insights work, I think give all of our merchants and designers better visibility to our customers, and to some degree we may have been a little bit distracted by the fact that it was a lot of data, and people were first learning how to use the Consumer Insights.

But we now have a great line of sight to our customers.

Supply chain work that we have been doing, the replatforming of our on-line significant systems changes, particularly with our inventory management, POS and financial systems.

So a lot of that heavy-lifting work, that took a lot of time and resources and distraction, to some degree, from our teams, is really behind us.

It now allows our teams to get really laser-focused on making sure that, 1, we have really compelling, amazing product.

And some of this other work, which we still believe was very necessary, is not really going to get in the way as we move forward.

So the merchants are empowered to do their jobs, to go after the assortments.

Given our supply chain capabilities today, with the lifting of quota, we actually can even be more dynamic than we have been in the past.

So we feel really good that the teams are focused on the right things.

That some of that infrastructure is behind us.

And, as -- Lauren, as you said also -- a lot of our growth initiatives are being done separately, with separate teams.

So whether it is Forth & Towne, or online groups, they really aren't a distraction to the core businesses, and the businesses -- and the people that they lead.

Thank you, and good luck.

Janet Kloppenburg, JJK Research.

Good afternoon, everyone.

Jenny, I wondered if you could talk a little bit more about your focus on balancing more newness with the basics.

It's a strategy you have been talking about since June or July of this year, and I'm wondering if you could tell us about the steps that you have taken to help that process, and what there is left to do, so that your team does find the right balance in the forthcoming seasons.

Thank you.

As I said, we have been focusing way too much on our value, and really chasing after that.

And we started really implementing some of that rebalancing, starting with fall.

We really need to do a better job of that.

And one thing we really realized is really our life cycle of some of our product, and really being more aggressive moving core into value, and moving value (indiscernible) our assortment.

And -- and really buying a lot more of our -- buying a lot more of our on-trend item.

I think we have the right item.

We just didn't buy it deep enough.

And I think we need to a lot more aggressive with that.

And when we do that well, it really shows, such as our tunic, our gypsy skirt.

Those we bought deeper.

And we need to do that going forward.

Dana Cohen, Banc of America Securities.

Oh, great.

Good afternoon, guys.

Byron, can we just go back over the SG&A and the marketing question?

Where is SG&A or marketing dollars going to be in the fourth quarter?

And I guess I don't quite understand, sort of the commentary about where SG&A is going be.

Because you are coming off of a quarter where SG&A is down about 5 percent, adjusting for the 30 million.

So why shouldn't we think that's the number, go forward?

And then second, for Paul.

I mean, what do you now believe -- I mean, if we go back to April, and we were out there, I think you sort of thought Gap division, this would be the very, very beginnings of a change, but more in spring.

But you were more confident about Old Navy.

I mean, what do you now think is a realistic assumption for when we should be measuring the turn?

Okay.

So Dana, let me begin with SG&A as I think you'll recall -- I'm sure you do -- at the beginning of the year, we made a switch, and our -- and introduced guidance as it relates to EPS and operating margin, and no longer are guiding to SG&A.

What I would suggest to try and be helpful, is taking a look at what we have done to manage SG&A over the past 3 quarters.

Earlier, when the question was asked, what were we doing about store labor, which is a big part of SG&A, we are looking to fund that investment in store labor, with trade outs of other SG&A expense.

And so we are trying to refocus what we are spending on those activities that will generate more value and contribute to an earlier turn around.

And at the same time, I want to re-emphasize that we are continuing to invest in those growth initiatives, such as our expansion of Banana Republic in Japan, Forth & Towne, our franchising initiative and international, all of which take a chunk of SG&A dollars to support, and our intent to continue to fund those is unwavering.

But didn't they take a chunk of dollars in Q3 as well?

They did.

Okay.

So just so I understand, marketing dollars will be down in the fourth quarter.

You are going to fund SG&A in the stores, but it's not an incremental, because you're going to find it in other places?

Dana, we did -- we are not guiding to SG&A.

I have not guided at all to marketing expenses in the fourth quarter.

But didn't you guys say you are not doing TV advertising at the Gap brand?

So would than imply -- ?

What I said before, was that we are investing more heavily in store labor, and we are reallocating what otherwise would have been planned expenditures, to help focus where we think the -- the investments where we think the returns are higher.

So I am not implying anything with regards to marketing expenditures in the fourth quarter or to SG&A in total.

But hopefully, have been helpful in giving you the philosophy by which we are trying to manage SG&A through the year.

And Dana, on my side, given the weakness in our performance over the past several quarters, I would expect ( inaudible) hold us accountable, see improvements in our business each season.

Having said that, you're right, in April when we spoke, we did feel that Gap was just going to see the beginnings, and that you would see more in '06.

As I said for Banana Republic, we believe that we're on the right track, and that we have seen some success with regard to our assortments being shifted to essentials.

But frankly, we should have done more.

And I think Jenny was very clear about what she wants to do with her.

And she is making course corrections, product corrections, so that we have confidence in our ability to change the product and the weighting of the assortments to better meet our customer needs.

We have got to get our marketing right.

We have got to get our trends right.

We have got to get our traffic back.

So, given the current trend, we're more cautious about how quickly we will be able to do that.

But you should hold us accountable, season to season.

Great.

Thank you.

Jeff Klinefelter, Piper Jaffray.

Yes, Paul.

I have a question about the Gap division.

And it really comes down to the debate between competition versus internal merchandising and branding challenges that you have.

And just curious, as you consider sort of the developments over the last year, the fact that several other sportswear based -- casual sportswear with more youth focused, the demographics have grown significantly in the last couple of years.

What is the appropriate size of a Gap store at this point, and number of stores?

Is it -- is it likely or possible that the sheer number of stores in square footage that you have out there is too much to support the kind of assortments that Gap delivers to their focused demographic?

Well, I think that -- first, it comes down to the big question, which is our product.

So I don't think that we have clearly demonstrated that we put our best foot forward with our product, and we believe that once we get our product right, we'll have a better understanding about the breadth and depth of the overall business.

Having said that, you have seen us really focus on optimizing our fleet.

And this has been done through a selection of closures in locations that we felt were just never going to be viable for us.

As well as optimizing some of the real estate square footage, allocating more square footage in some cases to women than men, and making sure that we are balancing across -- across the brand.

We think our target is very clear.

We think we have a great opportunity to serve a broad customer base.

But it's not going to work unless we have got the right product for that customer, and that's what Cynthia and her team are focused on.

And I think that we have the brand recognition and the power to serve a broad customer base, if we get our product right.

This is Byron.

I would add to that, with regards to square footage.

You have seen, as Paul said, over the past several years, that we have reduced significantly the number of stores assigned to Gap brand.

We will reduce a significant amount this year.

We are very, very disciplined around insisting all of the stores in each of our fleets meet a return on investment standard, which is an increment above our cost of capital.

And that will continue to be an important guidepost going forward, to which Gap brand, as well as the others, will be held accountable.

Just as a clarification, over the last 2 years, as this has unfolded, have you changed the hurdle rates, or have you identified different levels of profitability that should come from Gap stores within the chain?

And then also, just Old Navy stores, how many currently are in malls versus stand-alone or strip centers?

Jenny, on the second question? 15?

In malls?

So about -- make sure you heard that.

About 15 percent of the Old Navy stores are in malls, and about 85 percent in what we would describe as strip centers.

With regards to the hurdle rates, the answer is yes, actually.

Initially, when I first arrived at about 3 years ago, until we had a better handle at projecting sales rates, and until we had a better handle on understanding cannibalization within a market territory, we did assign a higher hurdle rate to, frankly, all of our fleets, not just Gap brand, And as we developed a much stronger command of our sales histories, of our cannibalization rates, of the under -- and gotten a better control over the underlying profitability of our stores, we felt more comfortable setting a hurdle rate that was somewhat lower, reflecting a better understanding of the risks.

But these hurdle rates are still a meaningful increment of our cost of capital, so that we are clearly aimed at creating value for our shareholder.

Great.

Thank you.

Stacy Pak, Prudential Equity.

Hi, couple.

One is, on the traffic that you mentioned for Gap, Inc., the negative 8-month to date in November, are all of the divisions sort of equally bad?

Or is there 1 that's better or worse?

On the faster lead time statement, can you give us any sense of the percent of product that will be on that faster lead time?

And then lastly, in terms of the sense that you feel the bit -- the product might be better, is there any metric that Jenny or Cynthia or Paul could quote us on, like, conversion or something like that, where you are seeing improvements since either the holiday set came in, or TV started for Old Navy?

So let me start, Stacy.

On the traffic.

So to be clear, the traffic, down 8 percent is through the first 2 weeks of November.

It is down across all of the divisions.

We're going to wait until our sales call at the end of the month to give more color on what it is by brand.

And Stacy I'll answer the other 2.

First with regard to speed to market.

Keep in mind that the area that we're focused on primarily is in the women's area, and specifically within Gap and Old Navy.

And a lot of this is going to unveil over the coming months.

So I would say I wouldn't assign a large proportion at all today it's a relatively small proportion.

But it does give us the flexibility to be able to go after that product that we think is trend-right, and over the course of 2006, we'll learn and we'll grow, and we'll hold more of that open to buy -- to be more successful as we go.

So overall, month to date, with regard to your question about metrics, we continue to be disappointed.

And I think it's fair to say that it really is the traffic lever that has been the driver across the board, that's really affected our business, more so than any of the other levers.

Right.

But I guess the question -- I mean Paul, both Presidents said they felt better about the product.

So I'm just trying to understand, is there any backup to that?

Or is it just a sense?

Well, first of all, Holiday 2 is really just getting out into the marketplace right now.

And I think you would expect my leaders and my chief merchants to be very optimistic.

But it's too early.

We are just landing Holiday 2 today.

First 2 weeks of November is really only reflective of Holiday 1.

So it would be unfair for us to judge it at this point.

Okay.

Thanks.

Kimberly Greenberger, Citigroup.

Great.

Thank you.

Good evening.

Paul, you talked about the need, going forward, to balance your focused on decreasing costs with having the right product, the -- you know sort of covetable trend-right product.

And I'm just not sure. 1, did I hear that properly?

And 2, how does a focus on cost savings prevent you from having the right product?

Yes, let me just -- this year, as quota was lifted, we did a significant amount of work in our supply chain to restrategize how we wanted to be able to source our goods.

That included consolidation of vendors.

It included migration of product sourcing to various countries.

And, a recognition that we wanted to capture the cost that we believed was in the system, as a result of quota changing.

Some of this came from us looking across the entire business to see where we can leverage, particularly as it related to fabrics, across the businesses.

So the teams clearly were looking for where was every opportunity for us to drive cost, lower unit costs on product?

What we didn't focus on as strongly, in hindsight, is to make sure we were balancing that initiative with our ability to increase quality and speed through our supply chain.

And that's where we think we could have done a better job of making sure that we were equally focused on that, because of the importance of it, compared to the amount of weight we gave to the cost side of the equation.

Okay.

That helps, thanks.

Paul Lejuez, CSFB.

Thanks, guys.

Can you talk about any regional differences that you have seen month to date?

Just wondering if you think weather had any sort of impact?

Also, can you tell us what the level of mark-down carry over was at quarter end versus last year?

And last, if you had to give yourself a grade by brand, a letter grade by brand, where are you now, and where will you be in spring?

Thanks.

So with regards to your first question on regional mark-downs -- regional impacts or trends, we will do that at the sales call.

I will say, though, that where there is cold weather, there is is often more business.

Having said that, on the mark-down piece, let's relate that to our inventory position.

So given the inventory guidance that we have given you, and then compared to where we were last year, we feel very good about our inventory positions.

This is across all of the brands.

And so when you look at it from a mark-down standpoint, I would say we are in a healthier position this year, versus last year going into Holiday relative to mark-down or liable goods.

And then I guess I'll answer that last question.

Having learned not to use analogies from my early baseball days, I'm not going to grade.

I would say that traffic is something that we have seen across all of the businesses.

And with regard to that, we are -- have not done everything we can to be able to improve that.

So certainly that's a challenge for all of the businesses.

Our teams are working incredibly hard.

I'm incredibly proud of how energized they are, how focused they are, and how determined they are to win.

So, I give the team -- I'll break my own rule.

I'll give the team an A for their effort.

But we know that we have a lot more work to do.

As I said, the traffic is a challenge across all of the brands.

Thanks, guys.

Good luck.

Jeff Black, Lehman Brothers.

Yes.

Thanks, good afternoon.

I guess I just had a question, Paul, about the overall senior management's merchandise philosophy.

And whether it's just too risk averse.

I mean, we hear what Jenny is saying, and we very much like that.

But I'm really getting to the guardrails, and while they seem to have prevented these wide margin swings, how do you respond to the criticism that the guardrails, in and of themselves, have structurally ensured a watered-down presentation.

And that if you keep them there, that's what you are going to get no matter what the teams do?

Thanks.

Yes.

No, it's a good question, Jeff.

But I think we think about it -- I'd have you think about it in a very different way.

The guardrails don't force gravity down to a common denominator.

In fact, what the guardrails do, is really allow us to be able to alter the percent of merchandise that we put into any 1 bucket.

Quite frankly, in the case of Banana Republic, some of our trend, or emerging trend, was more aggressive than what we believe we should have set it.

So it's not a guardrail with regard to an esthetic.

It's about how much inventory we are buying within a particular classification.

And as Jenny has rightly said, she overweighted a little bit of her assortments on the value bucket.

And it's not the -- the covetable product is not in that store.

It's just we didn't buy enough of it.

So, the guardrails do give us the ability to go back and reassort, based on what we are seeing clearly from our customers.

So it's not about watered-down product.

It's about how we're buying that product and making the appropriate adjustments to be successful going forward.

Operator, we have time for just 1 more question.

Brian Tunick, JPMorgan.

Yes, thanks.

I guess 2 questions. 1, I guess maybe for Cynthia.

Maybe without using the words fresh, casual and American iconic, maybe you could talk about why you think Gap brand is still relevant today, and why you think it's competitive positioning,today versus 5 or 10-years ago is still strong.

And then I have got another one for Paul.

Well, I'd say first of all, that Gap is a brand that's been beloved for many, many years.

And that what we know is that we have had -- we have done extensive consumer insight work over the last several years, and it's really anchored us in understanding that the customer -- what they expect from us.

And using other words, it would be key items that they can really count on, that have great color.

They have versatility.

It has a way for a customer to take those items and put them together in their own individual style.

And how they can outfit them again.

And it's got a flavor of updated classics, that's the handwriting that goes across that.

And I think what we know is that we haven't delivered on that in the past.

And that's our mission on the go forward.

And what you see today with fresh, casual, American style is a big part of it.

And we have also learned from our customer, that we have to put more specific quality and fit into the garments, so that they are reliable, and they can count on us for the things that they expect from us.

Okay.

And then I guess, lastly, for Paul, just looking at the order of things.

It sounds like store labor and conversion is a very high priority.

But product and marketing sort of sound like they are coming after, to get people into the stores.

So can you sort of talk about your thoughts?

It sorted of sounds a little reversed to us, maybe as far as a strategy goes.

Okay.

Brian, if that's the impression you got, let me change it for it.

Product is number 1, 2, and 3.

We are maniacally focused on quality, speed, making sure we have the right trend, the appropriate levels of assortment for our customers.

That is 100 percent of our focus.

We don't get that right, then everything else, frankly, is for naught.

We do believe that our customers -- and it's different for each one of our brands, do expect a certain level of customer experience in the store.

And that carries forward, both in how we visually present the merchandise as you would expect, as well as the labor models that we deploy.

And we think that that becomes really important, so that we have covetable product first, that we visually make it compelling.

We buy the assortment so that it has got a point of view -- a strong point of view.

And that our customers have the kind of ease around the store that you would expect.

And needless to say, we have got to get people across the lease line, by having effective marketing.

So product is our number 1 priority.

Okay.

Thanks, good luck.

Okay.

I would like to thank everyone for joining us on the call today.

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

Thank you.

This concludes today's Gap, Inc.'s third quarter conference call.

You may now disconnect .