蓋璞 (GPS) 2008 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen.

My name is Christian, and I'll be your conference operator today.

At this time, I would like to welcome everyone to the Gap Inc.

first quarter 2008 conference call.

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

(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 you consent to these terms and conditions, which are governed under California law.

You participation on the call also constitutes your consent to having any comment 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, Evan Price, Vice President of Investor Relations.

Good afternoon, everyone.

I would like to welcome you to Gap Inc.'s first quarter 2008 earnings conference call.

For those of you participating in the webcast, please turn to slides two and three.

I would like to remind you that the information made available on this webcast and conference call contains forward-looking statements, including those identified in today's earnings press release, which is available on gapinc.com, 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 February 2nd, 2008.

Investors should also consult today's press release which is available on gapinc.com.

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 May 22nd, 2008 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 the non-generally accepted accounting principle measure, free cash flow, which under SEC regulation G we are required to reconcile with GAAP.

The reconciliation of this measure to the GAAP financial measure is included in today's earning's press release which is available on gapinc.com.

Joining us on the call today are Chairman and CEO, Glenn Murphy and Executive Vice President and CFO, Sabrina Simmons.

Now I would like to turn the call over to Glenn.

Thanks, Evan.

And good afternoon, everybody.

I appreciate you joining us today.

As we stated in our press release earlier today, we were pleased with our first quarter performance in what was undoubtedly one of the toughest retail climates in recent memory.

We here at Gap Inc.

-- we continue to be committed to our three financial tenets for the remaining of this fiscal year.

Number one, driving a healthier margin business through a combination of tactics such as our commitment to solid inventory management.

Reducing and containing cost is obviously a critical tenet for us in 2008 and taking a more disciplined approach to capital spending in order to improve our ROIC.

We believe that our unwavering focus to these financial priorities will serve us well going forward, as we see no signs of improvement in the psyche of the American consumer.

Having said that, we recognize and acknowledge that a company like Gap with a leading market share that we need to internally advance the dialogue of how we will, at the right time, begin to stem and then recapture our loss market share.

So before getting to those conversations that Sabrina and I are happy to answer and some of your questions, let me just talk to you what has gone on in our brands in the last quarter.

At Gap brand, Marka and her team know they are on a journey and it feels good to all of us that our customers are responding positively to our renewed focus on color and modern classics.

They are moving the brand in the right direction and we are delivering on driving our healthier margin dollars.

At Banana Republic, some of our inside the four wall metrics have been positive, but to be honest our traffic trends have been a challenge.

Their direct competitors at BR have been uncharacteristically promotional and we are watching the competitive landscape very closely and Jack and his team are prepared to make the necessary adjustments to drive traffic if this promotional level that we're seeing currently was to continue.

At Old Navy this quarter struggled.

The woman's business -- the women's business is certainly the issue and we are dialing back the mix of fashion items to more seasonal basics.

As you would expect, we have the right level of focus and certainly a sense of urgency is being applied in the division, but the bottom line here is we're not happy.

Fortunately, our new faster pipeline will allow us -- will definitely allow us to reflect our product offering to our new refined consumer target, which is a young woman on a budget who buys for herself and she buys for her family.

So we look at our business going forward.

There's certainly a lot of work to be done inside all of our brands and we're clearly focused on the three financial tenets I mentioned earlier.

I know Sabrina is going to come on in a second and talk to you about a breakdown of Q1.

All I want you to know is that we have reaffirmed, once again, our guidance for the full year.

And we will make all of the right decisions going forward to make sure we actually execute and deliver on that guidance.

So, Sabrina, over to you.

Great.

Thank you, Glenn.

Good afternoon, everyone.

We are pleased that in the first quarter, we delivered on our strategy of achieving bottom-line earnings growth, driven by our focus on healthy merchandise margins and cost management.

I'll begin today by reviewing the quarter's results followed by an overview of our guidance for the rest of 2008.

First, highlights for the quarters.

Net earnings were $0.34 per share or $249 million.

This represents net earnings growth of 21% over the prior year, excluding last year's loss from the discontinued operation of Forth & Towne.

Gross margin increased 150 basis points to 39.7% versus 38.2% last year.

Operating expenses decreased by $92 million, and we repurchased 11 million shares for $216 million.

For webcast purchase events, please turn to slide four.

First quarter earnings were $249 million, which includes about $15 million of pretax earnings benefits from a reduction of interest-expense accruals.

This reduction was primarily the result of foreign tax events that occurred in the quarter.

The effective tax rate was 39% and weighted average dilutes shares were 736 million.

Turning to slide five, sales performance.

First quarter total sales were $3.4 billion, down 5% versus last year.

Total company comp store sales were down 11% from the quarter versus down 4% last year.

The six percentage point spread between sales growth and comps was driven by new stores and continued online growth.

Online sales grew 21% versus last year to $236 million for the quarter.

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

Turning to slide six, gross profit.

First quarter gross margin was 39.7%, up 150 basis points compared to last year.

Merchandise margin improved 310 basis points in the first quarter, which was partially offset by 160 basis points of occupancy deleveraging.

Gross margin dollars decreased slightly by 1% to $1.3 billion.

Although we were pleased by our growth margin improvement, we also have a goal of growing gross margin dollars.

Unfortunately, given the head wind space this past quarter, particularly at Old Navy, we fell just shy of this goal.

Please turn to slide seven for operating expenses.

First quarter operating expenses were down $959 million, down $92 million versus the prior year, driven by the following factors: first, lower store payroll primarily related to the decline in sales, second, remodel related expenses.

As reflected in our capital guidance for 2008, we are executing fewer remodels this year compared to last year.

As a reminder, the decrease in remodels is driven by Old Navy where we have chosen to put on hold additional remodels until we have solidified our store prototype plans.

As a result of our lower remodel count, we are not incurring relating costs like demolition which are expensed.

Third, we have marketing expenses.

Marketing expenses for the quarter were $93 million, down $21 million versus last year, driven by the absence of television at Gap brands.

I want to take a moment to put our Q1 expense savings in context.

While we were pleased with the results of our cost management efforts in the first quarter, we would caution against taking this quarter savings over last year and extrapolating it to the remaining quarters.

Operating expenses can and will vary by quarter.

For example, unlike the first quarter, we expect our marketing expenses in the second quarter to be fairly similar to last year's level of $88 million.

Turning to inventory on slide eight, we ended the first quarter with $1.6 billion in inventory, down 14% versus the prior year.

Inventory per square foot was $37, down 17% versus down 8% in 2007.

Entering May, we remained comfortable with our overall inventory levels.

Let me provide more color on how we think about our inventory.

One of our objectives is to drive gross margin dollar growth.

However, we must balance this goal with the long-term health of our brands.

By that we mean we want to achieve and maintain a certain level of regular price selling.

Given current traffic trends and the broader macroeconomic environment, we believe buying higher levels of inventory increases the risk of more markdown sales and puts pressure on markdown margins, thereby putting at risk our goals around regular price selling and brand health.

We continuously assess whether we're striking the right balance in inventory levels by analyzing key metrics, such as percent of goods sold at regular price, markdown margins and inventory turn.

While we have seen some recent improvements in these metrics, we have achieved higher levels in our recent history.

This indicates to us that our approach to inventory management is still appropriate.

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

First quarter capital expenditures were $114 million.

We opened 33 stores and closed 23 stores.

Company-wide, we ended the quarter with 3,177 stores and net square footage increased less than half a percentage point.

Regarding cash flow on slide 10, for the quarter, free cash flow defined as cash from operations less capital expenditures was an inflow of $62 million compared with an inflow of $159 million last year.

The difference was driven by higher bonus payout in 2008 related to our 2007 earnings performance.

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

With regard to share repurchases, we repurchased a total of 11 million shares in the first quarter for $216 million at an average price of $18.88.

We continue to utilize only excess cash to fund our share purchases.

We ended the first quarter with about $1.8 billion in cash and short-term investments.

Turning to slide 11, our outlook for 2008.

Though we're pleased with our ability to achieve bottom-line earnings growth in the quarter, traffic patterns and top-line results were challenging.

However, since the back half of 2007, we have managed the business in a manner that we believe is prudent given the tough consumer environment.

Therefore, we're reaffirming our guidance for the following metrics.

Full year diluted earnings per share $1.20 to $1.27.

Operating margins 8.5 to 9.5%.

Full year effective tax rate about 39%.

Full year capital expenditures about $500 million, and this includes about $130 million for new stores, $220 million for existing stores, about $100 million for IT, and about $50 million for headquarters and distribution centers.

Full year depreciation and amortization about $550 million.

Free cash flow about $900 million.

Please see today's press release for Reg G reconciliation of expected free cash flow.

We are updating our guidance for the following metrics.

Square footage, our store closure forecast has increased by 15 stores to about 115 for the year.

The increase is driven by Gap brand.

The number of store openings remains at about 115.

These figures include 15 store repositions, which are reflected as both an opening and a closing.

As a result, we now do not expect any net square footage growth in 2008.

Please refer to our first quarter press release for a summary of store activity and gapinc.com for 2008 store guidance by division.

Interest expense for the year, about $5 million.

Our prior guidance of $20 million is being offset by the $15 million of pretax benefit related to the reduction of interest expense that was mentioned earlier in the call.

We are providing our initial inventory guidance for the second quarter and expect the percentage change inventory per square foot at the end of this quarter to be down in the mid teens compared to last year.

In summary, let me reiterate our strategy for the year.

Drive bottom line earnings growth through healthy merchandise margins, maintain an ongoing cost discipline that is anchored on continuously looking for efficiency, while supporting the long-term health of the business and continue to distribute excess cash to shareholders.

Thank you and now I'll turn it back over to Evan.

That concludes the prepared remarks.

We will now open the call up to questions.

We'd appreciate limiting your questions to one per person.

(OPERATOR INSTRUCTIONS) We'll pause for just a moment to compile the Q&A roster.

Our first question comes from the line of Jeff Black with Lehman Brothers.

Yes, thanks very much.

I guess a couple of questions.

One on the cost of goods benefits, Glenn.

Have you made any progress there?

It seemed like we -- it seemed like the message was to assume that we get those sooner rather than later.

And then on the real estate plans, what are your thoughts around additional store closures?

I see we're going to go up to 65 it looks like at Gap this year.

But how far are we away from the divisional analysis and what does that initially look like, any light you can shed there?

Thanks.

On the cost front, we certainly got a little bit of benefit in Q1.

We've been working at it for the better part of six or nine months, so there is some benefit in Q1.

We continue to work aggressively with the people in our regional hubs.

As you know, we operate in almost 50 countries and we have five significant hubs and with brands and the hub leaders are working together to make sure we are coming to the market in an appropriate way, making the changes we have to make internally to guarantee we're going to get recognized for the cost that we, I would argue, should have been paying historically and are making some adjustments in all fronts of the business to make sure we can deliver on -- one of the priorities in our business is to get a reduced cost base and one of those key areas of reducing cost is cost of goods.

On the store front, I think what we've been -- and we'll have a much better sense, Jeff, in the next two or three months, but one thing we've been articulating is, will there be store closures?

Absolutely.

My view right now is we that will be closing stores going forward but at a decelerated rate.

We're going to have a portfolio of about 3,000 stores.

It's natural every year you are culling out some stores that just don't belone.

Some of those might be remodels -- or sorry, repositions or relocations.

But some of them will be closures that we just don't feel good about anymore as we look at our strategy by market and by region.

So some more store closures, I think, are certainly in our future over the next three years but at a decelerating rate and the real opportunity for us is going to be looking the a the square footage per store.

Great.

Thanks.

Our next question comes from the line of Dana Cohen with Banc of America.

Thank you.

A couple questions.

It looks like square footage growth was essentially flat in the quarter.

So can you talk about what is driving so much productivity in terms of the spread between comp and total, because online is only about a point.

And then, second, other than the marketing, is there anything in the SG&A dollars that we should think is non-recurring in terms of the lower payroll or the remodels, because you said marketing will be flat, but what about the other items?

Yes.

Great.

So first question, Dana, on spread, there is lots of in and outs.

But I think the three primary drivers, the one piece is online, that you mentioned and noted.

The other piece I noted was new stores.

So we get some spread from the new store openings.

And there is 33 in Q1 but it's on an anniversaried level, there is actually 43 versus Q1 last year.

What was square footage up in the quarter?

0.3.

So three tenths of a percent.

And then foreign exchange, actually, is another piece of spread.

So as you know, we have businesses in Canada, U.K., France and Japan.

And against those currencies, the U.S.

dollar weakened versus last year Q1 by about 15%.

So we got about $60 million in sales revenue from translation on those businesses.

And then on the SG&A.

And then on the SG&A, there is lots of moving parts.

I think there is nothing major to call out in terms of any one-times.

What I would tell you is, and I've mentioned this before, in any one quarter we do choose to make investments at certain times.

So as examples, we're growing our franchise business.

We just announced our new business in Russia with business partners and we're looking to grow our franchise business.

So there is different levers going up and down.

We do -- our objective is clearly to deliver expense reduction, but the degree will vary because, in certain quarters, we'll make choices to offset that.

But no particular one-time callouts besides the marketing.

Great.

Thank you.

Our next question is from the line of Jennifer Black with Jennifer Black & Associates.

Good afternoon and congratulations operating in a tough environment.

Glenn, I wondered if you are ready to talk to your back-to-school marketing plans.

And then I wondered if you could bring us up to date on managing your choice counts by divisions.

Thank you.

Well, it's a little premature to talk about back to school.

What we mentioned the last call and still holds through today is we've been rethinking what is the message we're going to have to back-to-school and the focus tends to be in this -- by brand with Old Navy.

So as we've redefined our target consumer who is a young mom, who is budget conscious, who is buying for herself and for her family and that will certainly be a focus of our marketing at Old Navy.

It's going to be making sure that we deliver on what the messaging is appropriate for that target audience, so making sure we get our right value messaging out will be certainly one of the focuses.

Exactly what shape or form it takes in terms of media and how it's going to look, that is still to be determined.

The key thing for us is that we're much clearer today on what we need the messaging to be.

Exactly how innovative and creative and what the spin is, is to be determined.

Okay.

And thoughts on choice count by division?

On CC count?

Yes.

I think the Gap brand has certainly, under Marka's leadership over the last six to nine months, taken a fairly aggressive stand on what their CC count is going to be and you've seen some reductions.

As part of the work we've at Old Navy the last three or four months, I would never characterize it as a page out of the playbook, but we are looking at our CC count and our program count more importantly at Old Nave and I think you'll see some of that show up a little bit in the fall and-- but certainly for the holiday season.

Maybe not to the same magnitude of reduction that Marka executed at Gap, but there will be some changes that will go down.

And I would say Banana Republic is pretty flat.

Okay.

Thanks so much and good luck.

Thanks.

Thank you.

Our next question is from the line of Barbara Wyckoff with Buckingham Research.

One, could you remind us of the lead time on the product cycle Old Navy versus Gap.

And then, second, on Old Navy, the Old Navy store fleet, could you please talk about your ability or willingness to exit leases on underperforming stores ahead of schedule.

And when you talk about right sizing the box, what is the right size of the box?

If it's a free standing store, what would you do with the rest of the square footage?

Could you talk about that a little bit.

Thank you.

Yes.

I'll take, Barbara, on lead times.

So generally what we've said for Gap Inc., most of our divisions have been at about nine months from concept to in store.

So Old Navy, fortunately, has worked hard on their pipeline and they have actually seen really nice increases or decreases to that.

So that is why we feel confident, given the assortment issues we have now and some of the changes we want to make in women's, that we're going to see some real improvement by late fall, unlike the old days where we might be talking about spring '09.

So that's a reflection of how we've been able to shorten the pipeline at Old Navy.

With regard to the Old Navy fleet size, we're always analyzing the fleet.

Every quarter we're looking at opportunities on lease actions.

It's very rare that we would pay anything to break any leases, because nearly every single one of our stores is on a positive cash flow, positive contribution basis on a four-wall basis.

So it doesn't really make economic sense, given the profile of the stores, to pay for breaks.

Okay.

And definitely from a size perspective, the thing that both Old Navy and Gap share is that they have an incredible range of different sizes.

You think of some other retailers that you likely cover or are a student of, the way we are, they tend to be very focused on some cases as close as one prototype size but never further than three.

And I think the real opportunity at Gap and Old Navy is once we get crystal clarity on what the prototype size is going to be going forward, which will likely be two for each one of those brands, is then to run what our current portfolio is against the prototype size and then make those adjustments.

We obviously feel pretty comfortable in Old Navy's case that the quality of the real estate is very good and that we will have no problem on those A+ centers finding the landlords who may want the excess space, as we defined it, or finding comparable or complementary tenants who would like to be beside an Old Navy and play off of that traffic.

So we're just doing the work right now.

And it will be simple math once it's completed.

But the message for today is getting away from the eight or nine prototype sizes and getting focused on a couple and will certainly bring us benefit going forward.

Okay.

Thank you.

Our next question is from the line of Todd Slater with Lazard & Company.

I was wondering if you would talk a little bit about the international franchise agreements that you guys have been signing.

How much revenue are you generating from those?

I know it's probably still small.

And how much should we expect this year?

And then how does that flow through the P&L?

Does it hit the revenue line and then pretty much flow straight down?

Thanks.

Well, we have been signing the international agreements at a pace that we're comfortable with.

We're currently in 13 countries and have over 70 stores.

The agreements we've announced recently that will take us into 17 countries, with the most recent one this week being Russia, I think we're pretty excited about what we've seen so far.

We -- the countries we approached were pretty thoughtful, the ones we thought made the most strategic sense initially.

And we've been testing the relationship.

We've never been in a franchise relationship historically.

I have a little bit of that background, not internationally, but in North America in my past.

And I think there has been some really good work by the team here, both finding the right franchisees, making sure our brands are represented appropriately, working with them on the right strategic real estate plans.

Good that we're going through the work we're going through right now in North America to make sure we don't replicate some of the missed opportunities in our real estate internationally as we have in North America.

So I think it's a -- we have a three- to five-year strategy that we have worked on hard with the team here figuring out which are the right countries to approach and when.

And we have three different models we can go to market with, which is our corporate model like you see here in North America and that we have in the U.K.

and France and Japan.

A joint venture model is a model that some people consider.

And a franchise model is obviously one we have selected to date to put into these 17 countries.

And with regard to the accounting, just recall that our model is that we sell the goods to the franchisee.

So the revenue we receive from directly selling our goods to the franchisee does get consolidated into our revenue.

Okay.

Great.

Thanks.

Our next question is from the line of Lauren Levitan with Cowen and Company.

Thanks.

Good afternoon.

Glenn, I'm wondering if you could give us your thoughts on pricing strategy for each of the brands.

I'm particularly interested relative to your comments that you made about Banana considering responding to some of the promotional activity they're seeing.

But as you're getting some of these sourcing advantages from leveraging your strength with the vendor community, how are you thinking about how much of that might go back into an adjusted pricing strategy relative to going into higher gross margins for the Company?

Thanks very much.

Let me take the second question first.

We've been really thinking strong and taking strong stands internally that we should as a business disaggregate AUC from AIRs, which are average cost from initial retails.

And that is a mindset that we, as a business, are looking at gross margin dollars per units as opposed to only focusing on IMU.

So as a business, even if we are able and continue to do the work we're doing to reduce costs on our AUC side dealing with our vendors, we still have to make the right decisions up or down, regardless of what the cost is.

The challenge for us is making sure we understand where our competitors are, how do we want to come to market on our initial retails, how do we want to promote to actually drive traffic but also drive conversion?

And we are really taking a new cultural approach internally that it really doesn't matter what the cost is.

That if for some reason we wanted to lower our retails, if that was a choice of ours, and some retailers make the choices in order to be competitive to who they believe are their direct competitors, then we better work our way down the P&L and take out costs somewhere else in order to make the numbers we've committed ourselves to make.

Or on the other side of the coin, if you think there is opportunities to get higher pricing because the market is moving up, it shouldn't be a determining factor just because you have lower costs but you should be prohibitive from raising your retails.

So from our perspective it starts first and foremost, clearly who are the competitors?

Who do you believe you need to target yourself against, whether it's direct or whether it's aspirational competitors?

How do you want to target your pricing and come out of the market in by category?

And then the cost is a secondary component and they come together to create gross margin.

And, of course, somebody in every single brand is the keeper of the summation of the AUC and the AIRs.

So it's really important work.

I'm sure every retailer will tell you that the people who control pricing in their business have a serious role to play, as do the people who control cost.

What we're trying a little bit in our business is to disaggregate those a little bit, make good, fundamental separate decisions.

When it comes to Banana, I don't believe that there is anything uncompetitive with their initial retails.

We've noticed with their direct competitors, they have been much more aggressive on promotions.

I'm in stores, as I think you know, every Thursday, Friday and Saturday and I've just witnessed from where I first saw nine months ago to what I'm seeing today, I'm seeing some of Banana's direct competitors being much more aggressive on promotions.

And what I was trying to say earlier is that if that means that we need to step up our promotion activity, not necessarily lowering our initial retails, but being more promotionally conscious and putting promotions in place that are right for Banana, its brand and its particular customer that we are trying to attract, then we will certainly do that in order to defend our position.

That's helpful, Glenn.

One follow-up on the first part of your answer.

That cultural change that you described, how far along are you in that process?

Do you feel the merchants are today thinking about bringing in product the way you've described and the pricing strategies that we see currently in place, are they already reflecting that desegregation?

Not yet, Lauren.

We have certainly done some minor structural changes within the brands to make sure that the merchants have the right experienced individuals working with them to help them on this cultural shift and how we look at actually price optimization and gross margin dollar per foot optimization.

Maybe a little bit of benefit from that in the fall, but I think we'll see it an '09 opportunity.

Thanks very much.

Our next question is from the line of Marni Shapiro with Retail Tracker.

Congratulations on a good job.

Could you talk a little bit about full price comps versus markdown comps at some of the brands and any kind of color you can give us around the improvements in the markdown margins, was that just at the Gap brand or did you see that across the board, because the inventories were pretty lean at Banana as well I believe.

Yes.

We don't segment report, Marni, but let me try and be helpful still.

So at the Gap Inc.

level, what we saw was we definitely had improvement in regular price margins.

So those expanded healthily.

Even the bigger expansion was in our markdown margin.

So again at the Gap Inc.

level, our markdown margins improved and our reg margins improved.

What I will say is, not surprisingly, given the head winds that Old Navy faced in the quarter, they actually had pressure on their AUR and their margins.

The other brands, I think it's fair to say, overall were the drivers to that improvement.

Great.

And could I just ask one follow-up?

Were you able to cut back the inventories at Old Navy for the back half, given the sort of shift in focus that you guys are executing right now?

Yes.

That's a great callout.

And, in fact, one of the drivers to the mid-teens Q2 inventory guidance we've provided reflects the fact that we have brought inventories down further at Old Navy in line with the traffic they're experiencing.

But also to reflect the fact that we are working on their product as we speak.

Excellent.

Great.

Good luck with the spring/summer season.

Thank you.

Our next question is from the line of Richard Jaffe with Stifel Nicolaus.

Thanks very much.

Just a quick follow-on regarding the marketing efforts or the pull back we've seen in marketing and now what looks like an opportunity particularly in the second half of the Gap division to ramp up advertising.

Can you talk to that -- the opportunity to use advertising to address the traffic problems by division?

Well, we're certainly taking a look at a couple things.

One is what is the best way to spend the money that we have last year.

As we reported, we had $475 million in marketing.

So I think for me it starts off first is do we have the right medium?

Do we have the right message that is appropriate to either deliver in some cases incremental traffic or in some cases higher conversion while people are actually inside the four walls of our store?

Our view going forward is pretty simple is that, if any one of our brands can hit on the following areas, we are more than happy to spend marketing money as long as we can justify the investment.

First and foremost, their product is right and on target.

That's critical to us.

Secondly, that we believe the stores are going to represent and merchandise and actually provide the customer service model inside the stores.

When people show up, because of marketing, we can actually deliver in the four walls of the store.

That's the second part that is really important.

Third, do you have a message?

What is the message?

Is it just something on a billboard or do you have something that is imaginative, creative and makes absolute sense for that target consumer?

And, last, is the consumer ready to respond to the market?

What is the psyche of the consumer?

How are they feeling at that moment?

So I wouldn't say we have to have all four of those perfectly aligned at any given moment.

We will spend marketing for the remaining of the back half of this year.

That's a commitment we're making.

We know we have to continually speak to customers, particularly in the times we're going to.

My theory, and I think it's shared by every one of the brand presidents, is we are more than content to step up marketing investment in order to get a return on that investment, if the following four sets of criteria do exist.

So right now the only brand that we mentioned right now that is getting close to hitting on those four cylinders, if you want to call it, is Gap brand.

So that's a consideration.

But not a decision we've made.

Because the one thing that they'll figure out is the consumer in a position in the back half of the year to actually respond to that marketing message.

So we're always having conversations here.

Some of the savings you saw Sabrina talk to in Q1, the $20 million in less marketing at the Gap brand was a decision we made because that criteria wasn't in place.

We could not justify the $20 million spent.

So going forward, if it makes sense, we'll choose the medium.

We want to make sure, again, we're innovative and imaginative.

We're happy to spend the money.

And how much wiggle room do you have versus the spend versus the 475?

Is it 20, 30% that you don't have to spend how much is committed already or is it all uncommitted at this point?

I think it's a mix.

There's certain things that obviously have longer lead times that you commit yourself to.

have longer lead times that you commit yourself to.

But the back half marketing, some portion, 475 was last year's number, if you start looking at it, it's more of a Q4 opportunity.

And we'll make those decisions.

And I think we obviously are already having conversations now about Q4.

Most good retailers are.

And if we can see those four sets of criteria being aligned, we're happy to, one, spend the money.

Or, secondly, not spend the money if we can't see return.

And just to be clear, we're happy to invest more money to get a return if everything is lined up.

Got it.

Just a quick question on the the improvement in pipeline.

You talked about Old Navy.

Would that similar improvement be true for the Gap division as well?

I would say Gap brand is about the same it was, maybe a week or two better.

And Banana Republic is exactly the same as it was.

Thanks very much.

Our next question is from the line of Christine Chen with Needham & Company.

Thank you.

I wanted to ask about the marketing campaign at Old Navy.

This year the TV ads certainly are much more contemporary in nature than they were last year.

As you continue to evolve the merchandise, how do you see the marketing campaign evolving?

Our view would be that the one television campaign that is starting tonight for Memorial Day weekend is certainly more appropriate to the discussion earlier on the target consumer, particularly the message about the budget consciousness and the value component which is critical, again, value our way.

Do I think that it's going to hit on imagination and innovation?

No.

That's back to the earlier question.

We had some commitments we had made, particularly when it comes to television.

Those tend to be longer term commitments.

We've been able to adjust the creative, so it's a little more modern as you suggested but a little more hard hitting this weekend when it comes to the value message.

I don't think you'll really get a sense of the creative -- that we're going to put forward for, I would argue, all three brands until into fall and holiday.

And making sure that the creative we put forward is completely reflective of what the target consumer is for all three brands, even though we know and we've known for a while what Banana Republic and Gap's target consumer is and how they should show up.

Most of our television -- not most of, all of our television investment is with Old Navy.

And now that we've recently shifted and redefined that target consumer, I think you'll see that closer to fall and the holiday season.

Okay.

Great.

Thank you.

And good luck.

Thank you.

Our next question is from the line of Dana Telsey with Telsey Advisory Group.

Good afternoon, everyone.

As you evaluate where you are today and where you want to be, do you foresee the opportunity to achieve perhaps the most recent peaks in '04 of a 39% gross margin and a 12% operating margin?

How much do you see would be dependent on top-line growth and how much do you think would come from internal efficiencies?

Thank you.

Hi, Dana.

It's Sabrina.

I think that's a really fair perspective.

What we're looking at is focusing on the improvement that we should be tracking to and we're looking at our recent history.

So, recent history, the last three and four years, we definitely hit operating margins, as you know, at the 12% level.

We see no reason that that is not a very good aspiration for us to have in the nearer term.

We've obviously guided this year to 8.5 to 9.5.

We will use both levers to get there and those levers being both disciplined cost management, but as well and importantly, growth in gross margin dollars.

Because for the long-term we believe the bigger opportunity as we set out to gain back market share is in the gross dollar margin growth.

Thank you.

Our next question is from the line of Paul Lejuez with Credit Suisse Boston.

Gross margin.

Is it safe to assume that in the back half of the year, even though you come up against some improvements in merchandise margin that you achieved in the second half of '07, that you are still, in fact, forecasting higher merchandising margins?

And then also on the margin line, can you talk about the leverage point on occupancy, whether it be from a comp perspective or total sales perspective?

Yes, you cut off, Paul, at the very beginning.

But I think I understand your question is around second half merchandise margins.

Yes.

So we haven't guided explicitly to the merchandise margin, but what we will tell you is it's clearly our objective to keep going in the direction that we have been going, where we are driving to healthy merchandise margins.

And that is a key part of our strategy.

We think our continued discipline in inventory management enables that strategy to become an achievement.

Whether we do it or not, we'll see how things turn out.

But that is clearly the objective is to keep marching in that direction.

And then the second part of your question was?

The --

The ROD.

Yes.

So on ROD, I think it's fair to say with the current state of our fleet now where we actually have culled out the most unproductive stores over the last four years, it's very difficult to actually leverage ROD on a negative comp.

I won't say it's impossible at the low negative single digits, but it's very difficult to actually leverage ROD on a negative comp.

Got you.

And just one quick follow-up to Dana's question earlier on currency.

You mentioned what it did to your top line.

How much did it help earnings?

I'm going to say it's immaterial to earnings overall.

Because as it helps revenue, it also translates our expenses of our international subsidiaries at a higher dollar number and also their rent and occupancy and depreciation.

So when you get to the earnings level, it's pretty immaterial.

Great.

Thanks.

Good luck.

Sure.

Thanks.

Our next question is from the line of Brian Tunick with JPMorgan.

Hi.

Thanks.

Was curious, Glenn, you've said before how you would like to see the stores playing a role in the winning and you try to make the business be more localized.

Could you just update us your past couple of months so far, if you've seen any progress there and when we could see some of that?

I think it's really early days.

I think we first had to get some information to the hands of our stores that didn't have before, and that's completely our fault.

And I won't take you through the gruesome details, but just suffice to say that our stores really didn't have the kind of data they should have in order for them to be able to make some of their own decisions.

So that part is pretty much on its way in terms of getting the information down, explain to them how they actually interpret the information to make better decisions.

And some of our brands have taken portions of their zones and various responsibility and tested giving our stores a little more accountability.

And allowing them to make some decisions that we feel comfortable with.

It's a fine line between having chaos in your business by giving stores full accountability and then losing the localized flavor and feel for a mall or a streetscape store in Seattle versus Miami.

So I would say we historically erred on being much more controlling and we've trying to find the middle ground.

The benefit of that, I hope, because I've been personally disappointed last November and December by seeing how vanilla and generic our stores were around the country and, as the seasons begin to change, I'm hoping that in most of our brands we'll begin to see the better merchandising decisions at store level.

That is round one.

There is other things that we put on a list of potential opportunities our stores can be involved with.

But it starts with them understanding it, being trained and becoming confident.

So we're in the early days.

But certainly, my experience in the past given the right set of guidelines and explanation and encouragement, is that you have to make the odd mistake every now and then to find out what is right, and that can be a big opportunity for us in the future.

And how about an update for the leadership at Old Navy?

Well, we've got Tom Wyatt in the seat.

He has done a very good job so far on a number of different fronts.

But whatever you make a change, first of all, somebody has to stabilize the people who are there and he has done an excellent job on that front getting the team motivated.

He led the discussion on the target consumer and then the first 30 days and got the team to look at where they have been, look at where they were going and then make the decision that I articulated today where they think they have to go to.

So credit the -- Tom and the team for doing that.

We're looking -- we've been very pleased but a number of people have put their names forward.

And I've met a few and I plan to meet a few more.

And it's just now trying to find somebody who I think can understand that brand first and foremost, have an appreciation of the value segment, have some good rooted merchant skills that can complement my skills because that's not my background, even though I understand the process and I appreciate it and I'm involved, it's not necessarily my background.

And somebody can fit inside of our structure and culture.

So, we're confident that in the next number of months we'll narrow it down and be able to make a good decision.

I know that people at Old Navy are anxious for that.

But in the meantime, to be honest, I think Tom is doing a very good job over there in the last ten weeks that he's been filling that chair.

All right.

Great.

Thanks and good luck.

Thank you.

Our next question is from the line of John Morris with Wachovia Securities.

Thanks.

My question would relate to, I guess, the Gap division in particular, Glenn and/or Sabrina.

Patrick Robinson's influence, are we beginning to see that at this point, to what extent?

If we're looking at the product, how would you describe that influence presenting itself.

And then from your perspective and understanding, how is the changing the nature of the relationship of working with Marka?

How are the two of them integrating in terms of the impact on the store assortment?

Thanks.

I think Patrick, being as modest and humble as he is, would say that he's had limited impact on what you're seeing in the Gap stores right now, which is summer.

Truth be known, he has had very solid influence of what we see in our stores today, particularly on this latest delivery that came in last Tuesday, that we call internally summer two.

But his influence from concept all the way to delivery from the full nine months that Sabrina was talking about earlier will really be felt in the fall.

And that is some of the product that he showed at fashion week back in January in New York.

But his influence right now has been felt.

I've always said, and I'll continue to say publicly in these kinds of situations or internally in the office, Patrick's influence while obviously he gets pride of authorship and he gets rewarded and recognized for the product that he designs and creates.

His leadership skills inside the office and his ability to attract great talent is something that when Marka hired him, I'm sure she didn't know she'd get a double win out of hiring Patrick.

In terms of the relationship, I think it's great.

And you're forgetting one person, which is Gary Muto.

I think the combination of Patrick and Gary in New York who are an amazing team, and obviously Gary has much more responsibility than just merchandising and design, but he's the President of Gap Adult.

But between Gary and Patrick first and foremost under Marka's vision and leadership is the reason that we took a step up in the conference call and say that we think customers are responding positively.

We're starting to feel better about what we're seeing and we're looking certainly forward to Patrick's full line being presented, I think it's mid August it shows up for the fall season.

Very helpful.

Thank you.

Thank you.

Operator, we have time for one more call.

Our final question comes from the line of Jeff Klinefelter with Piper Jaffray.

Thank you.

Just a couple quick questions for you.

Could you just talk a little bit more about the relationship between comp sales and merch margins, Sabrina, and meaning, going forward if you continue to see this kind of negative traffic trend, what sort of merch margin can you deliver?

You have that very strong performance in Q1.

And the second is on Old Navy.

Other strategies you're considering for productivity enhancements, looking at other space utilization, even other maybe brands, other category brands coming into the stores at this point?

Yes.

I'll start with the first part, Jeff.

I think it's really important to say that comp store sales are really important to us.

I mean, we obviously want to get to positive comps.

We obviously want to gain market share back.

Our path there, though, we are first and foremost focused doing that with healthy margins.

So we're very careful not to fall into just buying comp by buying units and selling them at markdown.

We're really holding firm on our inventory discipline to drive healthy margin percents.

But, again, we know that to drive profit, we need to drive healthy gross margin dollar growth.

So can we achieve both in the interim?

I think it's fair to say that it's more difficult when you buy inventory as lean as we're buying, it's more difficult to positive comp, certainly.

I don't think it's impossible.

We had in April, Gap brand with a flat comp when their inventories were down significantly.

So we want both, but we are in the short-term focused more on delivering the healthy margins.

And at Old Navy I think, first and foremost, we make decisions that are self-serving for us, which is one the size of the box and the stores we're going to have going forward, I mentioned earlier that the likelihood of two prototype sizes.

And then the excess space, I think we have lots of options.

I think we certainly want to work with our partners in the landlord community and we always have co-tenancies that we find are appropriate to Old Navy, so I think that those discussions are just beginning.

We don't have the full strategy done, but we've had some preliminary discussions.

And I look at our breakout of our portfolio of a thousand stores, we have 700 of those thousand that are non-mall stores.

So they're either in power centers or really strong strip centers, beside very good, attractive, long-term national retailers.

So I suspect that landlords will have no problem putting somebody beside us that we feel is appropriate to complement our brand.

And in some cases, we may decide this is certainly not a position that we're taking strongly today, but we may decide to work with somebody who could take out some of the space and actually be complementary to the overall flow and build on the image and certainly be, again, complementary to the consumer that we're now targeting.

So lots of options available to us.

Early days.

But I think we're going to complete the work in the next few months and then start to go into execution mode.

Thank you.

That's very helpful.

Just one other quick question.

Q1 versus this year versus Q1 last year, in terms much the composition of those transactions, was there much difference in terms of the bottom-to-top ratio year over year?

I don't think there is anything to call out, Jeff.

Probably a little variation by brand, but no major callout.

Thank you.

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.

Ladies and gentlemen, this concludes the Gap Inc.

first quarter 2008 earnings conference equal.

You may now disconnect.