蓋璞 (GPS) 2005 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to Gap, Inc.'s fourth-quarter conference call. [OPERATOR INSTRUCTIONS] The conference call and webcast are being simultaneously recorded on behalf of Gap, Inc. and consist of copyrighted material.

They may not be rerecorded, reproduced, retransmitted, rebroadcast, or downloaded without Gap, Inc.'s express written permission.

Your participation represents your consents to these terms and conditions, which are governed under California law.

Your participation on the call also constitutes your consents 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 415-427-2175.

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

Please go ahead, ma'am.

Good afternoon, everyone.

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

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

I'd like to remind you that the information made available on this webcast and conference call contain forward-looking statements, including but not limited to forecasts relating to earnings per share, comparable store sales, incremental stock option expense, free cash flow, share repurchases, dividend amounts and timings, operating margin, inventory per square foot, gross interest expense, depreciation and amortization, capital expenditures, effective tax rate, store openings and closings, real estate square footage, 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 found in our annual report on Form 10-K for the fiscal year ended January 29, 2005.

Investors should consult our quarterly report on Form 10-Q for the quarter ended October 29, 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 February 23, 2006 and we assume no obligation to publicly update or revise our forward-looking statements, even if experience or future changes make it clear that any projected results expressed or implied therein will not be realized.

This presentation includes a non-generally accepted accounting principle measure, free cash flow under -- 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 Gap Inc.com.

On today's call Byron Pollitt, our CFO will cover our financial performance and outlook for 2006.

Following Byron, Paul Pressler, our CEO will summarize 2005's performance and address 2006 priorities.

After Paul, Jenny Ming will discuss Old Navy.

Followed by Cynthia Harriss who will discuss Gap brand.

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

We expect the call to last about an hour.

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

Thank you, Sabrina.

Good afternoon.

I'd like to begin the call today by discussing business performance in 2005 and then give you our outlook for 2006.

Here are a few highlights from 2005.

We delivered full-year EPS of $1.24 and operating margin of 10.9%, both of which are at the upper end of our previous guidance.

We generated 951 million in free cash flow this year, above our prior-year guidance due in part to aggressive management of inventory.

As a result, we ended the year with over 3 billion in cash and short-term investments.

Our strong financial position has allowed us to return excess cash to our shareholders.

We doubled our dividend to $0.18 in 2005 and we repurchased 98.5 million shares at a cost of $2 billion.

Since we began our share repurchase program in 2004, we have spent $3 billion repurchasing 146 million shares.

Now please turn to slide 4 for a review of earnings performance.

Fourth-quarter earnings were down 11% to $337 million or $0.39 per share.

Please note the fourth quarter effective tax rate was 36.4%, 120 basis points below the prior-year rate.

This reduction contributed $0.01 of EPS for the quarter and the year and was primarily due to a nonrecurring tax benefit.

The full-year effective tax rate, including the nonrecurring benefit, was 39 -- 37.9%.

Full-year earnings were 1.1 billion, or $1.24 per share versus $1.21 per share last year.

Fourth-quarter weighted average diluted shares were 870 million and full year weighted average diluted shares were 902 million.

Please turn to slide 5, sales performance.

Fourth quarter total sales were $4.8 billion, down 2% versus last year.

Despite the overall decrease in sales, we are pleased that our new e-commerce platform successfully handled the highest volume ever and on-line sales grew 20% during the fourth quarter.

Total company comp sales were down 6% in the quarter versus down 3 last year.

And while full-year comp sales decreased 5%, total sales were down 2% to $16 billion.

This 3 percentage point spread was driven primarily by new-store openings during the year.

Please refer to our earnings press release for total sales and comps by division.

Turning to slide 6.

Gross profit.

Fourth-quarter gross profit decreased 9% to 1.6 billion.

Gross margin was 34%, down 280 basis points compared to last year. 150 basis points of this decline are from lower merchandise margins.

And the remaining 130 are from the deleveraging of rent, occupancy, and depreciation.

Of the 130, 100 basis points are the result of a change in the way we record payments made in France to secure the right to lease stores.

Following discussions with the SEC, we determined that these payments, most of which were made in the late 1990s, should be more appropriately amortized over the term of the leases versus our historical practice of capitalizing them as intangible assets with indefinite life.

This change reduced fiscal year EPS by $0.03 per share.

Full gross profit -- full-year gross profit was 5.9 billion, gross margin was 36.6%, down 260 basis points from last year with 220 basis points from lower merchandise margins and 40 basis points from the deleveraging of rent, occupancy, and depreciation.

Of this 40, 30 basis points relate to the amortization of French lease rights.

Please turn to slide 7 for operating expenses.

Fourth-quarter operating expenses were down 5% to 1.1 billion.

Full-year operating expenses were 4.1 billion, down 6% or about $275 million below last year.

To put this reduction in perspective, please keep in mind that 2004 expenses included 105 million related to early retirement of debt.

There were no such expenses incurred in 2005.

And 2005 expenses were reduced by, first, the reversal of a $58 million sublease loss reserve related to our building in the Mission Bay area of San Francisco.

Second, a $42 million reclass of certain sourcing expenses to cost of goods sold.

Third, lower marketing expenses primarily driven by our decision not to run a holiday TV campaign at Gap Brand.

And, four, lower than normal bonus expense related to 2005 performance.

Turning to inventory on slide 8.

We ended fourth quarter with 1.7 billion in inventory, down 7%.

Inventory per square foot was $43, down 11%.

Please turn to slide 9 for capital expenditures and store count.

Full-year capital expenditures, 600 million.

Full year, we opened 198 new stores and closed 139, ending the year with 3,053 stores.

Square footage increased 3% this year, in line with our guidance.

Please refer to our press release for end of year store count and square footage by division.

Regarding cash flow on slide 10.

Full-year free cash flow defined as cash from operations less capital expenditures was an in-flow of 951 million, down 227 million versus last year driven primarily by higher capital spending.

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

As noted on the January sales call, our $500 million stock repurchase program is complete.

We repurchased a total of 18 million shares in the fourth quarter at an average price of $17.62, including commissions.

Also in 2005 we doubled our dividend to $0.18.

We ended fourth quarter with 3 billion in cash and short-term investments, of which only 55 million is restricted.

Now let's review 2006 outlook on slide 11.

Given the uncertainty regarding the timing of our turnaround, month to date February traffic that is down 13%, and management's expectation that total comp store sales will remain negative in the first half and turn modestly positive in the second half, we are adopting a cautious outlook for 2006 and guiding to a modest $1.23 to $1.27 per share, including option expensing.

When assessing our 2006 EPS guidance, please keep in mind that achieving the same $1.24 in 2006 that we reported in 2005 calls for delivering $0.06 of EPS to compensate for the following factors benefiting 2005.

First, 2005 did not include stock option expensing under FSAS 123 R. Our outlook for 2006 EPS includes this impact, which we estimate will be about $45 million pretax or $0.03.

Second, recall that fiscal 2005 includes a $0.03 net benefit from a combination of four previously disclosed factors as follows.

First, a $0.04 benefit related to our decision to occupy Mission Bay.

Second, a $0.01 benefit for a lease accounting true-up.

Third, a $0.01 benefit from a lower effective tax rate driven primarily by a nonrecurring tax benefit realized in Q4.

And, finally, fourth, these benefits were partially offset by $0.03 of catch-up amortization related to lease rights in France.

Moving on to the remaining 2006 guidance metrics.

We expect operating margin for 2006, including option expensing, to be 10 to 10.5%.

Full-year gross interest expense is expected to be about $40 million.

We expect inventory per square foot at the end of both the first and second quarters to be down in the low single digits compared to last year.

Regarding store activity for fiscal 2006, we expect to open 175 new stores and to close 135, with openings weighted to Old Navy and closures weighted to Gap.

Please refer to our fourth-quarter press release for a summary of store activity and GapInc.com for 2006 store guidance by division.

Full-year net square footage is expected to be up between 1% and 2%.

Full-year capital expenditures are expected to be $675 million.

And here's the breakdown.

Stores, 470 million with 270 million for new stores and 200 million for existing stores.

IT, about 130 million; headquarters and distribution centers, about 75 million.

We expect to generate at least $900 million in free cash flow.

We expect full-year depreciation and amortization to be about $535 million.

And for the full year, we expect the effective tax rate will be about 39%.

An increase over 2005 due to the absence of the nonrecurring benefit in 2005 and a higher worldwide effective tax rate in fiscal year 2006, primarily due to the continued growth of our business in Japan, where tax rates are higher than in the U.S.

Reflecting management's confidence in the Company's long-term prospects and its ability to generate and sustain strong cash flow, we intend to increase our annual dividend per share by 78% from $0.18 per share in 2005 to $0.32 per share in 2006.

We expect the timing of our dividend payouts to occur in late April, July, October, and January.

And regarding share repurchases, today we announced the authorization of a new $500 million repurchase program.

We expect to repurchase $250 million of this authorization in the first half of 2006.

The amount of this authorization, in part, reflects our cautious outlook regarding the pacing of our turnaround.

Thank you.

Now I'll turn it over to Paul.

Thank you, Byron.

None of us is satisfied with our overall 2005 business results.

This past year we pursued new approaches to gain market share but did not deliver on our expectations.

We know we can do better.

The strength of our brands, our balance sheet, and our talent provide a solid foundation for success.

Today each of our brand presidents is clear about what needs to be done and are acting with a tremendous sense of urgency to win back our customers.

During a year when we had disappointing top-line results, we used our strong cash flow to double our dividend and complete a $2 billion share repurchase program.

We also delivered on our growth initiatives.

Successfully launching Forth & Towne, introducing Banana Republic in Japan.

Developing a franchise capability and signing our first agreement and building new on-line systems resulting in what we believe are the best websites in apparel.

With that said, we know that our long-term success requires growing our top line.

As we discussed on our third-quarter earnings call, we are 100% focused on improving the product in each of our brands.

And although we saw improvements in our style aesthetic and assortments for holiday, it was not enough to reverse our declining traffic trends.

Our traffic insight suggests we have not lost our customers.

They are still visiting our stores but because they've been disappointed with our product offerings they are shopping us less frequently than before.

We believe that by making product improvements each season, our traffic will follow.

As we've said, it will take more time to see our efforts reflected in our results.

We believe that traffic lags product improvements by one or two quarters.

So we expect that the first half of 2006 will be challenging and that we'll begin gaining traction in the second half.

Each team has built and is executing their turnaround plans, including clear product strategies, supported by effective marketing and compelling store experiences.

In many cases we are changing the way we work to drive execution and ensure accountability.

Today Jenny and Cynthia will discuss progress at Old Navy and Gap.

First I'll share a high-level perspective on Banana Republic.

We will continue to execute to Banana Republic's affordable luxury positioning in a way that is approachable for our core customers.

Our product assortments will emphasize versatile essentials and we're focused on more clearly communicating this to our customers.

For spring we're getting behind key big ideas.

Classic white shirts and chinos with broader deeper investments supported by compelling windows, visual merchandising, and marketing.

Our print advertising featuring black and white photography reflects this focus on key items and everyday style.

To drive traffic, we are focusing our efforts on our most important market, New York.

Beginning this week and next week in Manhattan, Banana Republic will dominate key billboards, bus-stops and subway stations and we've invested additional payroll in stores to ensure a great shopping experience.

Following this test we will determine whether we will expand this approach to other markets.

In all markets, we are using the launch of our handbag collection to give customers a new reason to come back to Banana Republic this spring.

This is supported by magazine and newspaper advertising, windows, and focused store displays.

We are pleased that initial customer response to handbags has exceeded our expectations.

Now I'll turn the call over to Jenny.

Thank you, Paul.

At Old Navy in 2005 we focused primarily on competing on price.

And as a result, our product became less differentiated in the market.

While value remains an important part of the brand proposition, we know what's essential in setting us apart is offering special trend right products in a unique store environment.

In line with this positioning, the team has made several changes to ensure that we're getting trend right products into stores faster.

Now that the Old Navy designers are based in San Francisco, they're working more dynamically with the merchandising and production teams on a daily basis.

The teams are traveling to our sourcing offices and factories to make decisions more quickly and gain visibility to new innovations.

We created a fabric R&D team that find ways to replicate more expensive denim techniques on our base cloth and they taught our vendors how to execute those techniques within our volume and cost requirements.

And you can see this in our special edition denim.

Old Navy now has the ability to develop portions of our most fashionable product in three months.

This shorter lead time allows us to leave more open to buy opportunities, particularly in women's, to more quickly react to customers' response, and market trends.

With the specialty product filter in place, our merchants feel more confident investing boldly in core trends to reflect a focused point of view in stores.

So, for example, in March we are featuring stripes for the whole family.

And in April, we will have a pure and natural theme, including on-trend items like embellished tanks, skirts, rollup cargo capris and esprit dress.

Our spring and summer marketing class support two trend right fashion themes.

TV advertising will begin running next Thursday, beginning with a focus on stripes.

Then naturals.

We've also redesigned our circulars to better highlight products with more elevated photography and cleaner layouts.

In addition, we plan to add a buzz generating PR campaign for summer.

And for fall we are increasing our marketing investment in television, and magazine advertising.

Finally, to better showcase our specialty products, in April we are rolling out improved in-store signage and in July we are upgrading our front of store fixtures.

And as we told you last quarter, we are continuing to allocate payroll dollars to ensure that stores are neat, clean, and organized.

With our specialty focus strategic filter in place, we feel good about our plans to improve our products, marketing, and store execution.

And we're confident that we'll deliver improvements each season.

So now I'd like to turn the call over to Cynthia.

Thank you, Jenny.

Good afternoon.

On today's call I'd like to share with you the progress we made in 2005 laying the foundation for our turnaround and then take you through our key strategies for 2006.

As a reminder, I've been the President of Gap Brand for nearly ten months.

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

During 2005, we focused on three priorities that I believe are critical to renewing Gap Brand and successfully returning our business to health and greatness.

First and foremost we focused on re-establishing the essence of our brand by building on our heritage and the strong appeal that has made Gap a cultural icon.

Then, a comprehensive turnaround plan was developed.

It includes aggressive steps to improve our product, store environment, and marketing.

Equally important was attracting key leaders with expertise in critical areas to join our team.

I have designers and merchants for adult, accessories, kids, baby, and body.

Each bringing broad retail experience and a strong track record of leadership with high-growth companies and successful business turn-arounds.

While we are confident that these are the right strategies to deliver value, we are realistic that these changes take time.

Our expectation is our product assortments will get better with each season and more reflective of our brand essence.

Now I'd like to spend some time on what we're pursuing in 2006.

First, it all starts with product.

The Gap brand is casual and confident.

We are at our best when we interpret current trends through our Gap filter and create exquisite updated classics that are wardrobe foundations.

By being clear about who we are, we will deliver beautiful product to our customers with relentless attention to detail.

Our merchandising strategy to deliver this product starts with the assortment.

Our product assortment will be rooted in key categories and will re-establish Gap's authority as the place for T-shirts, hoodies, great clean bottoms, and most importantly denim.

And we're making changes in how we align our resources against these categories.

With smaller, more focused teams against each of these areas, we are creating clear accountability for ensuring that our product has trend-right design, quality fabrications and trends, as well as consistent and perfect fit.

Designers and merchants along with production will travel periodically to key factories to personally oversee final specifications.

This will ensure the design intent is reflected in great product delivered to our customers.

Elevating our fabric and yarn selection is also important.

Specifically, you'll see cotton, cashmere, and sweaters, Modell blends and knits and a wealth of treatments in bottoms including a broader range of fashion washes in our denim.

We're also branding our product with innovative graphics and labeling.

These important design elements are distinguishing features for our products.

To that end we're developing a team dedicated to graphics.

Of course, great fit is another critical element.

We must get the fit right across the assortment and deliver consistently.

We will build product acceptance and loyalty with our customers through casual and confident Gap designs, quality, and great fit.

This in turn will drive greater regular price selling.

Next we are focused on creating the right store experience to drive traffic and to delight each customer that walks through our doors.

Our stores will communicate a clear point of view that is fresh, relevant, and represents the Gap aesthetic.

This starts with windows and in-store displays.

We are reintroducing visual experts in stores to improve the dramatic impact and clarity of our windows and to build displays that bring our products to life.

There will be clear destinations for each key category, customers will see signage and merchandising that makes it easy for them to find what's new.

Our tables will be well merchandised with key items and mannequins will show great ways to style and wear our product.

And we're focusing on delivering great service to each and every customer by developing sales teams that are knowledgeable about our product and passionate about providing extraordinary service.

Our customers are responding well to the newly remodeled stores in Denver, Hartford, San Diego, and New York.

We are working to bring the best ideas of these stores to our fleet.

But a comprehensive rollout of the new format will take time.

In 2006, we plan to remodel an additional 20 stores.

And our team will refresh 200 top adult stores with elements that most directly impact customers, such as visual presentation, new mannequins, upgraded hangers, and painted walls.

Finally, let's turn to marketing.

We're focused on creating inventive marketing that's fresh every month and clearly shows what's new at Gap.

Introducing versatile key items and building intrigue and frequency we will give customers a reason to come to our stores each month.

Integrated marketing campaigns will create buzz to inspire Gap's most loyal customers to spread the word that Gap is back.

Based on specific campaigns and our unique customer segments, different marketing vehicles will be used.

And we will continually evaluate our mix, including direct mail, circulars, print, outdoor, radio, and TV to ensure we're using the media that makes the most sense.

In closing, my team and I are very excited about the changes in the strategy we put in place.

Please bear in mind that change of this nature takes time.

But I am confident that we have built the right foundation to win and that we are on the right track with our product, store experience, and marketing.

Thank you.

In closing, despite recent challenges our ongoing ability to generate strong cash flow has given us the confidence to significantly increase our dividend and continue our share repurchase program.

And looking forward, we remain committed to delivering shareholder value through cash distributions and operating performance.

We will continue to pursue our growth strategies.

First, building and growing our lifestyle brands through real estate expansion and brand extensions.

Second, expanding our brands internationally, exploring China and franchising in smaller, more fragmented markets.

Third, building our world-class on-line business.

And, finally, creating new brands.

We recognize that our success depends on creating great product.

And we are aggressively taking actions to improve.

That is our number one focus.

We will support this with flawless store execution and effective marketing.

Gap, Banana Republic, and Old Navy are strong brands with many loyal customers who want us to get it right.

I'm confident that by maintaining our renewed focused on creativity and product we will win back more of these customers each season and when we do we will gain tremendous leverage from the solid infrastructure we've built.

That concludes our prepared remarks.

We will now open the call up to questions and we'd greatly appreciate callers limiting their questions to one each.

[OPERATOR INSTRUCTIONS] Your first question comes from Margaret Mager with Goldman Sachs.

Hi.

A couple questions.

Oh, you said one.

All right.

The operating margin goal, 10 to 10.5% down from the 10.9% in -- that you achieved this year.

What is it that's the key reason why you see it going down next year?

And I'm also just curious in your target for free cash flow for the year, what is your view of inventory?

Will it be a source or a use of cash?

Thanks.

So Byron I'll answer that.

The -- with regards to the drop in operating margin to 10 to 10.5, the short answer, Margaret, is that it is clearly difficult to have a meaningful improvement in operating margin given the pacing of our turnaround and given the combination of negative comps in the first half with modest positive comps in the back half.

Operating and margin holding at 10.9 and improving on 10.9 really must follow from great product that brings back the traffic and drives higher regular price selling and we're all being very realistic that as our product improves, we should expect a lag for traffic to follow.

So the 10 to 10.5 is reflective of our cautious outlook for '06 and the pacing of our turnaround.

With regards to inventory, as you know we guide inventory each quarter so we have guided out over the first two quarters of this coming fiscal year and will update that quarterly.

Your next question comes from Janet Kloppenburg with JJK Research.

Good afternoon -- everyone.

I was wondering if Jenny could talk a little bit about what's going on at Old Navy in terms of the competitive profile.

Maybe if there's been some focus groups with the target customer to find out where they are diverting their shopping patterns and perhaps if there are categories of business, Jenny, that are performing well that you could capitalize on while downsizing some other businesses.

And, lastly, I was wondering why you would focus on expanding Old Navy at this time when it seems like the product assortments are not yet what you'd like them to be?

Thank you.

Okay.

Regarding our competitive set, I think our competitive set is pretty fierce right now, obviously.

But talking to our customer where we really feel is really our product, they really want to have specialty product from us.

And they also want our value commodity opening price points, too.

So it's really having that balance that we're looking for.

And that's what we're focusing.

And now that our specialty filter is back on our core product, it will help us balance our products to the right place.

As regarding to category, our strongest category is always the same categories that we're known for, which is knits.

We have a very strong market share and then of course our bottoms.

Cargos, twills are very strong right now and continues to do so.

With regards to why we are continuing to expand Old Navy, clearly it's been a challenging year but I will say that the business model for Old Navy is rock solid even with the challenging year just experienced and so we are very supportive of continuing to expand units in Old Navy and to take market share through real estate expansion without hesitation.

Your next question comes from Lauren Levitan with Cowen and Company.

Thanks.

Good afternoon.

I am wondering if you could update us on your suite optimization and rationalization plan and results of those strategies?

You've got another big year of closures for the Gap division planned, I'm just curious if you can give us a sense of how much more opportunity you had to rationalize that change and maybe elaborate on is there something associated with the brand positioning of the Gap division that creates a greater opportunity to close stores, like are there certain types of markets or venues that you're exiting to and hoping to recapture those sales elsewhere?

Thanks very much.

So, Lauren, as you may recall, we have indicated that 2001 was the last major year of Gap store expansion.

And that with average leases -- with a lease that averages five years in duration before options, we fully anticipated that we would have an above-normal level of closures through fiscal year 2006.

And so the closing levels that we just outlined are fully reflective of that earlier expressed point of view and we will continue to guide one year out with regards to closures.

So with the 135 closures we've outlined for the coming year, that's the extent of our guidance at this point.

And with regards to the benefits associated with this, the leveraging that we have delivered on the ROD line, rent, occupancy and depreciation, has been consistent and largely due to the closing of those Gap stores.

And replacing them now with Old Navy stores which generate more leverage relative to -- the fleets on average.

Your next question comes from Stacy Pak with Prudential.

Hi.

Thanks.

I was hoping that Jenny and Cynthia could grade the spring deliveries at their respective brands.

And, also, I understand the comments you made on traffic lagging product, but whether you guys believe you guys being Jenny and Cynthia that conversion should improve as the fashion improves or whether we shouldn't see an improvement there?

Hi, Stacy, this is Cynthia.

Hi.

Boy, that's hard to grade your children here.

What I would say is certainly if we'd say the spring product is not reflective of what you'll continue to see with the progress that we're making with the Gap Brand that we've been talking about.

I'd say first and foremost as I mentioned in my speech here is that we're going to be very focused against key categories so that you'll see a stronger point of view in the store than what you see today.

And whereas that we're getting some good traction on specific items within the categories, I don't think that we see the dominance that you'll see in the future.

So those four key categories of T-shirts, hoodies, casual bottoms, and denim, you should be able to really walk in the store and know that that's what we really stand for.

And I think that's where we can improve upon it.

And I think we certainly know that with the additional product acceptance that's going to make a change in all of the consumers' behavior with improved conversion and all of the rest.

Yes.

Okay.

We just dropped spring three in the store last week so obviously it's a little early and we do have marketing that's behind it starting with next Thursday, the TV is all going to be about stripes for the whole family and then followed by that is on Sunday we will drop a new circular which is much more elevated than previously, better photography, a lot more updated, a lot cleaner.

So we are inviting our customer back into our store.

But when you're disappointed -- we disappointed our customer for several seasons now, so it takes time to win them back into our store.

The same thing, I think as Cynthia said.

It's hard to grade your children.

Especially, as an ex-merchant I always really love our product and as you and I talked about it's really having the confidence to step in and buy the big items and I think you will see incremental improvement month by month, season by season and that's what we're focusing on.

And what about the conversion, Jenny?

We always have pretty good conversions but I think what we really focusing on now is traffic.

That's the piece that I think is lagging behind.

We expect when product is better, we will see traffic hopefully improving.

Thank you.

Your next question comes from Brian Tunick with JP Morgan.

Thanks.

I guess first for Cynthia.

It just sounds like your conversation about graphics and hoodies and track jackets and denim it just sounds like the business is going after more of the teen customer.

Don't you think there's already enough capacity out there for that customer?

Or is there something I'm missing, maybe you're just trying to focus more on basics?

And then for Byron or Paul, maybe just some comments about which division got hurt more in 2005 as far as operating metrics.

I know you don't give operating margins by division but just which division might have more opportunity for 2006?

Thanks very much.

Hi, Brian.

This is Cynthia.

So first of all the foundational categories that I'm talking about, those are really a part of Gap's heritage and that's what we've stood for over the years.

We've just not had the strength and authority maybe in the last several seasons.

In addition to that, those are the categories that -- where we have the greatest strength already and where we're getting the most traction and that's what our customer counts on.

We're a brand that can support a breadth of customers with the right style aesthetic.

And I think the difference between some of the more teen markets is Gap's a more wholesome all-American brand and we can do it in a way that's going to have the right appeal with that Gap aesthetic.

So we're very encouraged by what all of this can be for us.

So, Brian, with regards to which division or divisions have the most opportunity looking ahead, what I would say is that when we look back over 2005 performance, the shortfalls in traffic and the related deterioration in margin was across all divisions.

So it's across the board.

And when you asked the question where is the greatest opportunity going forward, we would reply it is -- it's basically related to the size of the division since all have opportunity for improvement and so the answer there is Old Navy and Gap.

All right.

Thanks very much.

Your next question comes from Kim Greenberger with Citigroup.

Great.

Thank you.

Good afternoon.

I was hoping that Jenny and Cynthia could speak to speed to market.

Jenny, I know you had some success last year with a few key items, particularly in spring and summer.

In 2006, how -- what percentage of your inventory can you keep open to buy until 90 days out so that you can, -- I guess improve the accuracy of the buy?

And what efforts are you making internally to share some of the best practices in terms of speed to market with the Gap brand and Old Navy?

Thanks.

Well, now that we have our New York team in San Francisco working alongside with our merchandising and production team, it really has really helped and improved our speed to market.

And we are increasing our open to buy -- leaving it more open.

We started with about 10% last year and it's growing.

As we roll through the year we feel we are doing a better and better job.

But mainly it's really in women.

Because that's where the most opportunity is to get the right fashion.

But I think we can't forget that our product -- our entire assortment is not just about fashion.

Our basics are pretty much monthly replenishment and then we also have our value-opening price point commodities, like a two by two rip tank or our perfect T that is about four to six months, which we -- by placing at four to six months we get the best quality and the best price that we can get from our vendors.

By -- so when you look at the whole pipeline, you get monthly replenishment and you get speed to market plus you have a little longer lead time from four to six months.

So we see -- it is an area that we can grow into even more so an as we move forward.

So this is Cynthia.

I would say for Gap Brand the word that I'd use is for us to -- first of all we acknowledge that we're big and we need to be nimble and that's our job to get nimble and to be faster.

And the word that I'd use is focused.

And that's what we've been doing is to get our teams focused so that we can be more nimble and laying that as a foundation.

Specifically, as you know that we've hired key leaders for the kids baby maternity with Pam Wallach and Tom Wyatt will be joining our team in two weeks to be the President of Body.

That gives us focused, strong, decisive leadership to really drive those businesses.

It also allows me to spend my time more focused directly with our adult team.

In addition to that, we have divided our teams and been very focused against the key categories that I mentioned.

So making it clear and clear accountabilities between design, merchandising, planning and production, so that we get ourselves set up to be able to do that.

And that we're well on the way of making changes in how we develop and bring product to market so that we will be faster, more effective, and have stronger execution overall against the product.

Your next question comes from Mark Friedman with Merrill Lynch.

Thank you.

Good afternoon, everybody.

I was wondering if you could talk about the new Gap prototype, how did that perform and whether you can give us the various markets or anything about what you've learned about it so far and what was the latest outlook on expansions and updates to that format in 2006?

Thanks.

Hell, this is Cynthia.

As you know, last year we remodeled 60 of our stores and this year we have on the docket to remodel 20 of our stores.

And what we've learned so far is certainly our customers are -- we rate them very positively and what we can see is that if we say those stairs compare to control markets that they've had stronger increases in those markets on comp sales driven predominantly by traffic.

So generally overall we're very favorable about those and we're enthused about what we'll learn from this.

Just -- we're just anniversarying those stores.

So what we've learned this year will give us a level of confidence about how we'll expand in '07 and beyond.

Meantime, as I mentioned in my earlier remarks, is that we're going to take the best of those elements to our top 200 stores.

Those are our most productive stores and it's the lion's share of where we'll get some real traction.

They are also in our key most visible markets.

And when I say refresh, it's less than a remodel and more than a little paint with us.

But you'll see a visible difference in the store and we've called out the best elements from what we learned in the store remodel.

And be able to do that physically with the stores.

But it's more than even the physical plan.

What we've also learned with those is the elements with the service, the windows, all of the other elements that we put with the stores.

So the -- kind of the short answer is we're very favorable about it.

We continue with the remodels but we want to jump start it because it will take us a period of time to get that in the fleet and you'll see these top 200 stores and we're targeting by Q3 that you should see a visible difference in those markets.

Your next question comes from John Morris with Harris Nesbitt Gerard.

Thanks.

Good afternoon, everyone.

I guess Paul maybe this is for you.

I know you've sort of answered this a couple different ways but let me try to ask it this way.

I think given -- stepping back and looking sort of from a 30,000-square foot perspective.

Given the new buyback and the very significant increase in the dividend you're clearly sending a signal of confidence to the market, which is great.

But that coupled with a cautious outlook, the low traffic we're seeing in Q1, what is it that you see out there that gives you the confidence, maybe -- what is it that you see that we don't see that gives you the confidence to do that?

I know you talked about a lag in the product or at least in the traffic catching up with the product.

But what -- maybe some examples and some specifics about what you might see that we don't.

Thanks.

Yes.

I think -- I guess the 30,000 level or maybe the 100,000 level, we have amazing brands.

We know we have tremendous loyalty through our customers.

And as I had said on the -- on our -- my talk, is that we do believe that it's more of a frequency issue than it is a loss of customer.

We have put in place a lot of the foundation, both from our operating discipline standpoint and more importantly from our growth opportunities for the future.

Which I'm very confident in our ability to long-term execute.

We know that right now we've got to get our product right.

We've refocused our teams and you've heard Jenny and Cynthia begin to talk about that.

That will take a little bit more time for us to be able to execute against it.

But when I look at strong cash flow that this company's able to generate I look at the solid positioning of these brands.

It really is simply getting our product right and then doing a much better job of supporting it.

If that comes to fruition, along with our growth initiatives, we have a high degree of confidence in what this company can do for our shareholders longer term.

Thanks.

Your next question comes from Barbara Wyckoff with Buckingham Research.

Hi everyone.

A question for Jenny.

Looking at your receipts first and second quarter, what percentage roughly would be devoted to fast fashion, the kinds of things you talked about chasing this year versus last year?

And then what would be the ideal?

And then the same question would be for the value priced basics.

Where are you going to be this year in terms of penetration to total mix for second quarter and then where should it be ideally?

First of all, I want to make sure I am very clear.

Fast fashion doesn't mean edgy fashion.

Fast fashion -- all fashion is really on trend fashion.

Right.

So -- no.

Because sometimes when people say fast fashion, they say, you know, go to that place first.

I mean fast turn-around fashion, I guess.

So for us really is wherever we see -- there's two ways we look at fast fashion.

One is that what is -- whatever is selling really well in spring, in February and March we will go back and reorder for summer.

That's one way of looking at it.

And then we also keep open dollars for any new fashion that's happening in the market and making sure that we could go back and chase into it.

So there's really two ways to look at it.

As for the value, opening price point.

This is something we actually have put some guardrail to make sure that we don't tip over too much on the valued part, which we kind of did the last year or two.

So we now are very, very focused on making sure that we do not go too value and making sure that -- but we -- in the meantime we have to remember we are at our best when we are a hybrid between our specialty and a value.

And our customer comes to us for both of that.

And we have to make sure that we have both of those products in the stores for her or him.

Okay.

Thanks.

Your next question comes from Gabrielle Kivitz with Deutsche Banc.

Good afternoon.

I was hoping you could talk about how you plan to manage the balance between basics and fashion at all three brands, the pendulum seems to have swung back and forth for maybe almost seven years now and hopefully there's been some learning each time but your heritage is obviously basics but the fashion-piece is obviously important as well.

Can you maybe just talk about how that balance is going to be managed or addressed at each of the three brands?

And then a question for Byron on the cash balance.

What you view is an appropriate level to maintain on the balance sheet?

I think in the past you've said about 2 billion unrestricted, has that changed at all?

Thank you.

Well, maybe I'll give you -- on the broadest level, Gabrielle, on the basic on fashions.

One of the things that we've talked about over the last several years is how each of the brands have built their guardrails and filters associated with their various customer segments as to what they believe is the right balance between on-trend, emerging trend, essentials, and basics.

And I think one of the things that we clearly have demonstrated over this last year that in spite of some of the challenges that we've had in hitting it completely right, we're not swinging the pendulum as we had done back in 2001 and that our overall financial performance is more stabilized than what it has been in the past.

And we feel that's really important.

Having said that, as we start to build more confidence in getting the assortment mix right, which is exactly what each of the brands are working on, we will continue to buy and have more confidence in our buying in those assortment levels to be able to win back our customer.

So on the one hand I think we're feeling very good that we have guardrails on place.

We know at the same time that as we -- each of the brands and each of them are different and they have different strategies for different customers, that we can win back those customers and make bolder investments when we're seeing the traction in those areas.

But those guardrails are very specific and as Jenny has said each one of our customers are coming in with a different purchase intent and that allows us to maintain the balance and make sure that we're also delivering respectable financial performance.

Okay.

With regards to the ongoing cash levels.

We are -- we feel today that it is still very prudent to maintain approximately 2 billion of cash unrestricted on the balance sheet.

As I mentioned, the restricted doesn't have much play anymore.

We're down to about 55 million of restricted.

Let me just say, though, that we are absolutely committed to distributing the excess cash, getting it off the balance sheet and distributing it back to shareholders above that 2 billion level and after we've made sure that the growth requirements of the business have been fully funded.

I do expect over time as the business continues to demonstrate strong sustained cash flow, that we will be bringing that level down below 2 billion but that's not today.

Great.

Thank you.

Your next question comes from Dorothy Lakner with CIBC World Markets.

Thanks, good afternoon.

Can you hear me?

Sure.

Thanks.

Wanted to ask Cynthia a question of something she referred to earlier about working with smaller teams and thereby getting I guess closer to product categories that you're making changes in.

I just wondered if she could elaborate a little bit on that -- on that initiative?

And then secondly just wanted to hear about progress on the international front.

Obviously you've opened Banana Republic in Japan, you've been working with getting local -- more locally designed product into the stores and I just wondered if you could comment on the success there?

Thanks.

As it regards to the reference that I made about smaller teams, what we're really clear is that we want to ensure that we have the right talent and we hold the team accountable but also ensure that they have the right decision-making responsibility with that.

So we are just being very explicit and very clear about those small groups of team members that will work closely together and again as I said, the whole intention with this is for us to be speedy, on-trend and to be able to put our -- a complete time and attention to ensure that we have that right fit, quality, et cetera.

So it's really about right talent, very focused, and right leadership to help guide them.

And then on the international front, a couple of things.

One, we did deliver on the two pieces of growth that we felt were important in opportunities.

One was bringing the Banana Republic to Japan and we're very pleased with the performance to date.

And then, secondly, we spent time this year building both our capacity to be able to enable the company to do franchise and, in fact, did our first deal, which we're excited about.

But keep in mind that 2005 really was the transition year where we were bringing our merchants, our planners, our marketing folks.

Many of which were being hired indigenously to those groups.

So we've had a couple of small wins and a couple of areas with our products where they've been able to do local assortments but we're going to see more traction as we move forward as those folks are seated for longer periods of time.

Will we see any in the second half of '06 or is this really an '07 story?

Well, I think we're going to see hopefully some season by season improvements but keep in mind that for the international group it probably lags a little bit.

Okay.

Great.

Operator, we have time for two more questions.

Your next question comes from Dana Telsey with Telsey Advisory Group.

Good afternoon, everyone.

Can you please talk a little bit about the sourcing by each division?

How -- how do you want open to buy to be -- how much do you want open to buy to be for each division versus fixed product in order to be more trend right?

And I think you had mentioned in the past about sourcing goods closer to home.

Where do you stand in that effort for each of the different divisions?

And do you see it helping your merchandise margins and the ability to achieve regular full-price sell-through?

Thank you.

Well, hi Dana.

Hi.

Maybe I'll start on the broader sourcing question.

Different from the open to buy for the different brands but we talked about this year and we have executed as a result of the lifting of quota our ability to work more closely with vendors to be able to take advantage of some greater efficiencies by looking at all of our sourcing across the entire company.

Whether that be with fabric or some of our cut and sew opportunities.

Some of the migration that we spoke about all came to fruition.

Our ability to place more of our goods with our best vendors.

All of that is giving us leverage both in terms of cost and quality.

But the teams are really also focused on leveraging these vendors for speed and innovation.

And that's where we do leave our open to buys opportunities.

It gives us the chance more dynamically to go into the marketplace and work with our vendors to make that happen.

I think the open to buy is really very -- by category, by season, by brand, hard to kind of describe on an individual basis.

But I think overall philosophically you are hearing us speak to the greater urgency and need for speed.

Our ability to have more dynamic relations with our vendors that's going to allow us to hold more open to buy and be closer to our decision-making at the time for the season for our customers.

Thank you.

Your final question comes from Donald Trott with Jefferies & Company.

Good afternoon.

Could you please give us an update on consumer acceptance of Forth & Towne and any modifications of that format that you might be contemplating?

Sure, Donald.

First, overall we are very pleased with the launch of Forth & Towne.

You know there's our five stores.

What we're learning so far is that customers that have come in and bought are buying -- are really, really excited about the concept.

When we look at all of our levers.

Our average transactions, our conversion levers, our UPTs.

We are actually very encouraged and to a degree exceeding expectations.

I will say that not unlike the brands, that we're a little disappointed about the overall traffic that we're seeing today, but for those customers and our loyal customers and our loyalty program, it's been very, very positive.

So we intend to continue to learn, adjust our assortments but overall we're very pleased.

We expect in '06 to open approximately 10 additional stores in 3 to 4 additional markets.

Thank you very much.

Great.

I'd 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 the Gap, Inc.'s fourth-quarter conference call.

You may now disconnect.