蓋璞 (GPS) 2008 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen.

At this time, I would like to welcome everyone to the Gap Incorporated fourth quarter 2008 conference call.

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

(Operator Instructions).

I would like to introduce your host, Evan Price, Vice President of Investor Relations.

Good afternoon, everyone, welcome to Gap Inc.'s fourth quarter 2008 earnings conference call.

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

I would like to remind you that the information made available on this web cast 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 10k, for the fiscal year ended February 2, 2008.

Investors should also consult our quarterly report on form 10Q for the quarter ended November 1, 2008 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 26, 2009 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 non generally accepted accounting principal 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 earnings 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.

Thank you Evan and good afternoon everybody.

Before I turn it over to Sabrina to get through the fourth quarter results and the full year results, I just thought I would start off by making a few comments.

First off, we were pleased with our results in 2008.

We had a 28% increase in EPS, a 16% increase in net earnings, we had free cash flow of $1 billion and we strengthened our return on invested capital.

And in Q4, which arguably was the toughest quarter in which we operated in, we almost achieved last year's EPS number by almost $0.01, as we did $0.34 against $0.35 the year before.

So, all in all, we were quite pleased with our results, and to be fair I think, as an organization, I'm very proud of not just people in the room with me today but the 150,000 odd employees that make up Gap Inc.

Who through their hard work and their dedication really made a very good year in a very tough economic environment.

As we think about next year and we sort of look forward, we have been talking a lot to customers as we go to stores and visit and hear what they have to say.

We've been looking at economic statistics like everybody else does, particularly unemployment numbers.

And what's clear to us is that as we try to predict what next year could look like, it looks a little foggy to us and it's not very clear.

Even with that said, we don't have any expectations that we will see much improvement, if any, in the next 12 months as we continue to operate in this very volatile environment.

As I keep thinking about our business I thought I would give you an update just on the three core brands that make up Gap Inc.

First off, let me talk about Gap brand.

I actually feel pretty good about Gap brand and the work that Marka and her team have done.

They've been together now two years, almost to the day.

And I just finished spending quite a bit of time with recently going through their summer product and I'm actually out a two day store tou with them next week looking at the Spring product in the stores.

And I think that the work they've done in bringing the product to actually the esthetic that Gap is known for and has been established on, you know continues to gain pretty good momentum.

And I think we feel good about the response we're getting from our store managers, from our customers and as I break it down and think about business by different sub brands, the kids/baby business has always been solid.

And that teams been together for three years and thats a very solid business that continues to perform well for us.

The body sub brand has been a complete redone -- completely redone in the last six months that business was taken over by Patrick and his team and now if you go into our stores you see the beginning of what the body business could look like going forward.

And the adult business is gaining momentum and we're feeling good about, again, how the team had positioned that properly to what the Gap esthetic and what the brand -- what the brand position target consumer is.

When we think about the Old Navy business , there is some light at the end of the tunnel.

And in order for me to explain that to you, I've got to first reference our January business where we had, by all measures, a very horrific comp number in January.

But in fairness to that team that was driven by last year where we were on liquidation for all 31 days in January.

And therefore created such a mount in the climb that in spite of best efforts, they could have never produced a kind of comp reresult or kind of performance that we would have been satisfied with.

With that said, I think that your luck in our store right now, there's a much better balance of product between basic, seasonal basic and fashion, which is something that Tom and his team have set out to get done.

I think our value message is coming out much clearer than it was six or nine months ago.

And internally one of the ways they're thinking about their business and positioning it is that its fun, fashion for all.

As you enter a Old Navy, you would notice again through the product, through the value messaging, that it is starting to get better.

It still has a very long way to go.

We are by no way pleased currently, even when you take the January performance out of the picture for a second.

We're still not pleased with where that business can get -- we're not pleased with where the business is today, but we do believer we are taking the right steps for the future.

Mark Breitbart, our new Chief Creative and Merchandising Officer joins us next month and I think he will definitely add a new dimension to that business.

Mark has great experience and clearly understands what Old Navy is about and where it needs to get to.

And tonight is the launch of a brand new marketing campaign which is critical to speaking to with customers whose may have left us over the last couple of years as we've gone back and forth in our market positioning, to the consumer.

I think the marketing message is clear, it's a appropriate for Old Navy and I think that's actually something we're looking forward to seeing how the responsiveness is from the customers and what the performance of the business turns out to be.

The Banana Republic business has been disappointing to us of late.

We may have mentioned that in the last conference call.

They obviously operate in a higher end market which has been more negatively affected by the other segments of retail.

But still we expect people to find ways to navigate their ways to navigate their way through these difficult times.

Jack and his team are hard at work, they've made some adjustments in their product mix between where to work, which is one of their key profiles of their brand positioning inside their stores.

Moving that a little bit more to a casual part of their business.

So, they are make some adjustments to the assortment, their working away very hard to try to get that business to at least -- as we think about Banana Republic as part of our portfolio, how do we get it to take advantage of what's going on right now in the marketplace under an affordable luxury positioning and start changing the course that we've seen over the last number of months.

In 2009, as we look at our business and look at the state of affairs, that are -- thats taking place right now in the marketplace, we feel good about how we're positioned.

I think that although the conditions are going to be very difficult as we talked about earlier we generate strong cash flow, we have almost no debt in our balance sheet.

We have almost $2 billion of cash on hand.

And even though next year is going to test all companies including the retail sector that we operate in, you know, in some ways we're a little more battle tested than most.

Before people were forced to take some of the tough decisions that have been taken -- that we've all been reading about over the last number of months, we were actually taking some of those -- taking some of that medicine and making the changes were necessary inside of our business.

Is there more that we have to do on that front?

Absolutely, there is more we have to do.

But, I think we're ahead of the pack and that would allow us to still concentrate on parts of the cost component within the company whether it's AUC, which has more room to go -- that we have more opportunity on that front which are average units cost.

On SG&A, even though we've taken out more than $400 million of SG&A in2008, we believer there's still opportunity in SG&A.

On our distribution logistics cost, we've got a great team leading that for us and we've seen some improvements in 2008 but in early indications are they will continue to make progress in 2009.

And our rent and occupancy, which through our real estate strategy will bring us some benefits through down sizes, through consolidations, but also when we think about rent and occupancy, we think about the fact that we've had to offer more value to our customers in order to see the performance -- in order to get them inside our store and get them to buy our product.

Our third party partners, like our vendors who make our clothes and manufacture for us in 48 countries, have also had to find a way to tighten their belts in order for us to get the best value from them.

Other third party arrangements, like marketing companies, et cetera, people who supply goods to us or supply -- who have supply arrangements with us have also had to do what they had to do, to bring us more value.

And we expect the same from our landlord community.

So, all in all the cost part of our business will continue to be a focus, we've made good end roads in 2008, there's more to do in 2009.

Two big priorities for us as we move forward is traffic -- traffic or lack there of has been the achilles heel of the company for a number of years.

You're going to see us really get a very keep focus on how we use our stores and through product and through marketing, while still being very conscious about the brand equity and the brand positioning of our total business.

How do we shift our focus and start to speak to customers and get them to cross the lease line with more frequency and get a bigger share of those customers in malls and in strip centers?

More details on that to come.

But obviously the marketing campaign that Old Navy is launching tonight is a example of a step we are taking and investments we're willing to make in order to achieve our goals of improving the traffic inside our business.

And lastly because we are well positioned in our balance sheet and have taken some tough steps over the last 18 months, we are in a position to make some investments in our company.

Even though we're going to have quarterly conference calls like this where we give the results of the past quarter.

We do believe, being custodians of the brand, we have to think long-term.

So, long-term investments for us include our store models, every one of our brands will have a new store model in the ground tested, by the end of Q3.

The order of that is going to be -- Gap is going to be further ahead, followed by Old Navy, followed by our Outlet business and then Banana Republic.

We're going to continue to open franchise stores in 2009, we're very pleased with our franchise business, hopefully there's more opportunity there, we'll continue to make investments in our online business.

The acquisition of Athleta has been -- has proven to be a -- quite a positive decision for us, the integration is going well.

So, we'll continue to make appropriate investments on line.

And lastly, our International business, which has performed better than our domestic business in 2008 also is an area that we will be making targeted strategic investments in the coming year.

All in all when we look at our business we feel good about the platform and the foundation we know we have more work to do, but we also know as an organization that we have to make some of these investments in order to position the company for the long-term.

So, with that being said, let me hand it over to Sabrina who will give you the update on Q4 and full year

Thanks, Glenn.

Good afternoon everyone.

I will begin today by reviewing our full year and fourth quarter results and then provide an overview of our outlook for 2009.

As a reminder our 2008 financial strategy was focused on delivering earnings growth through healthy margins and expense management.

We're pleased that for the full year we delivered on these goals, especially in one of the most difficult economic climates in decades.

And now full year highlights.

Merchandise margins improved by 310 basis points, operating expenses were reduced by $478 million.

Operating margin improved by over 2 points to 10.7%.

EPS grew by 28% to $1.34.

We generated free cash flow of $981 million.

Returned about $1 billion to shareholders through dividends and share repurchases and ended the year with $1.7 billion in cash net of debt.

For web cast participants please turn to slide four for fourth quarter results.

Fourth quarter earnings were $243 million.

Diluted earnings per share were $0.34 and fourth quarter weighted average diluted shares were 706 million.

Turning to slide five, sales performance.

Fourth quarter, total sales were $4.08 billion down 13% versus last year, total company comp store sales were down 14% in the quarter.

Full year title totals were down 8% to $14.5 billion.

And full year comp store sales decreased 12%.

Please refer to our earnings press release which is located on gapinc.com for total sales and comps by division.

Turing to slide six, gross profit.

For the quarter merchandise margins improved 80 basis points.

Offset by 160 basis points of occupancy deleveraging.

Gross margin was 34%, gross profit was $1.4 billion.

For the year, merchandise margins improved 310 basis points driven by reductions in average unit cost and better markdown margins.

The improvement was offset by 170 basis points from occupancy deleveraging, gross margin was 37.5%, gross profit $5.4 billion.

Please turn to slide seven for operating expenses.

Fourth quarter operating expenses were $991 million down $217 million versus the prior year.

Store related expenses like store payroll, packaging and supplies, which tend to vary with sales, were the primary drivers of the decrease.

Other drivers for reductions in marketing and lower corporate overhead expenses primarily in the area of bonus and payroll and benefits.

Marketing expenses for the quarter $138 million, down $11 million versus last year.

Full year operating expenses were $3.9 billion, down $478 million versus the prior year.

Marketing expenses for the full year were $435 million down $41 million versus last year.

Turning to inventory on slide eight.

We entered the fourth quarter with $1.5 billion in inventory down 4% versus the prior year.

Inventory per square foot was $35 down 6.2% on top of a 15% reduction in 2007.

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

Full year capital expenditures were $431 million.

We opened 101 new stores and closed 119.

These figures include 17 repositions which were recorded as both an opening and a closing.

Company wide we ended the year with 3,149 stores and square footage was down slightly to last year.

Regarding cash flow, on slide ten.

We're very pleased with our cash flow generation and the strength of our balance sheet, which provide us with flexibility as well as a solid foundation for navigating these volatile conditions.

Full year cash flow, defined as cash from operations less capital expenditures, was an inflow of $981 million.

We have virtually no funded debt in our balance sheet, and plan to repay the remaining $50 million in four days on March 2, when it comes due, we ended the fourth quarter with about $1.8 billion in cash.

Our strong cash flow generation along with our healthy cash balance, allows us to continue self funding our operating needs, while maintaining a significant cash reserve.

Please refer to today's press release which is located on gapinc.com for a regG reconciliation of free cash flow.

With regards to cash distribution in the fourth quarter we repurchased about 12 million shares for $146 million and for the full year we repurchased about 46 million shares, for $745 million.

Now, I would like to share with you our approach to 2009, please turn to slide eleven.

We continue to manage the business in a prudent manner focusing on the levers we can control.

That said given the economic environment and its uncertain impact on consumer spending we believe there is a much wider than usual range of possible earnings outcomes for the full year.

Therefore we are not providing full year earnings per share guidance for 2009 at this time.

However, we remain committed to being transparent about our business, so I would like the share with you our approach to 2009.

Our financial priorities remain the same.

Delivering healthy merchandise margins, maintaining our discipline around cost management, generating free cash flow and focusing on return on invested capital.

I'll now provide additional insight in to each priority.

First delivering healthy merchandise margins.

Our goal is to deliver healthy margins in the context of the challenging times.

The two levers that we can control in this area are managing inventories and reducing our average unit costs.

With regard to inventory, as we stated before, we view traffic as a proxy for consumer demand.

And while traffic trends are an important -- and current traffic trends are an important input for our inventory buying decisions.

While we realize defying inventory down makes achieving positive comps unlikely, we intend to continue applying the principal in 2009.

We would rather sell less inventory at healthier margins than risk being in reactive position of having to clear excess units at low margins.

Therefore, we expect the percentage change in inventory per square foot at the end of the first quarter, to be down in the high single digits, on top of a 17% decline last year.

The other factor that can support healthy margins is a further reduction in average unit costs.

Due to the factors -- due to factors like excess vendor capacity, lower commodity prices, combined with our size and our financial stability, as Glenn said, we're highly confident we can achieve this goal.

Although we're confident about our inventory position and our average unit costing, in this environment average unit retail and therefore merchandise margin, will be difficult to predict.

Second priority is cost.

In addition to our focus on average unit cost savings, we remain committed to reducing our operating expenses.

However, given that we reduced SG&A by nearly $0.5 billion in 2008, the level of savings will be less in 2009.

We expect first quarter 2009 operating expenses to be down $10 million to 30 million versus -- versus Q1 last year.

Marketing expenses in the first quarter of this year are expected to be up slightly compared to the $93 million we spent in Q1 last year, driven by investments in our newly acquired business Athleta.

Our third priority is cash, our target cash balance is about $1.5 billion.

Our primary objective in investing our cash is principal preservation and liquidity.

Unfortunately given current market conditions we expect the yield on our $1.8 billion of cash to be close to zero in the near term.

With regards to cash flow, our history demonstrates that we consistently generate significant free cash flow.

Since 2005, we've generated over $4 billion in free cash flow despite negative comps.

Free cash flow will continue to be an important priority in 2009.

Our fourth priority ROIC.

In light of the anticipated earnings head winds we're moderating our capital spend for 2009 and expect it to be about $350 million.

A decrease of about $80 million over the prior year, driven by fewer new stores.

Here is the breakdown.

Stores about $230 million.

With $60 million for new stores and $170 million for existing stores.

IT, about $90 million.

Head quarters and distribution centers about $30 million.

We expect to open about 50 stores, roughly half of those are international.

And the rest are weighted toward our outlet business.

We expect to close about 100 stores weighted to Gap brand.

And we expect full year net square footage to decrease about 2%.

Please turn to slide 12, for a summary of the guidance I just provided.

And some additional full year 2009 metrics.

Depreciation and amortization about $550 million for the full year.

Affective tax rate about 39%.

Now, let's turn to cash distribution.

Our philosophy regarding returning excess cash to shareholders remains in tact.

We are maintaining our annual dividends of $0.34 per share.

However, given that our cash balance is now more in line with our target of about $1.5 billion, we will likely slow our share repurchase program in 2009 especially in the first half.

As a reminder, we're very pleased that since 2004 we have returned about $7.5 billion to shareholders, $6.5 billion in the form of share repurchases and about $1 billion in dividends.

In summary, as Glenn said we are well positioned to navigate this downturn.

Our healthy balance sheet and ability to generate significant free gash flow are true advantages that allow our globally recognized brands to compete effectively this year as we move forward with our strategic initiatives.

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

That concludes our prepared remarks, we will now open up the call to questions.

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

(Operator Instructions) Your first question comes from the line of Lorraine Maikis with Bank of America Merrill Lynch.

Thank you, good afternoon.

Just -- I saw that you're planning to open a number of stores in addition to closing some.

Can you just talking about why in this environment you're taking the step to open new stores and just give us an idea of maybe of the performance of the outlet if that's whats driving those openings?

Yes, I would say it's two ways Lorraine, one is that as I mentioned in my remarks that we believe in our international business -- namely the corporate international business we control in the UK, the Republic of Ireland, France and Japan, we still have some opportunities to open some stores.

One of those is -- Banana Republic is really just has one store currently, and its at Region Street in London, so we see some opportunities for Banana Republic in the UK, in Japan as we go forward there's also some Banana Republic opportunities, they're more store in -- store in store opportunities in department stores and after that really it's an outlet play.

Some outlet opportunities in North America, mostly in Canada.

Where we only have two outlet stores right now.

And in Japan where we only have ten and in the UK, where we have less than ten.

So, the math I think -- as Sabrina and I did last night, is about 75% of that number you heard herr quote, that 50 new stores is split between international and outlets.

And then could you give us an update on your real estate initiatives on how the discussions with the landlords are going about closing or consolidating stores?

You know when it comes to the store closures, those are always conversations we've had and as leases expire, and they get terminated that we have a chance to close stores where -- to a combination of relocations and pure closures, we're looking at about 100 stores in 2009 that we are going to be dealing with.

And that's just a normal course of business thats about 3% of our fleet.

And we've had those conversations on a much larger scale in terms of closures over the last five or six years.

In terms of our ability to reposition locations, I think that they recognize we are trying to consolidate stores where that makes sense.

This is mostly kids and baby locations in the Gap locations and create a combo store as we call it here, but also downsizes of Old Navy's.

The environment will always know if things are buoyant.

There's always going to be some different kinds of conversations and negotiations, when times are a little rougher, like they are right now,I think that there's no such thing as the perfect time to have these conversations, but I think our landlords understand our strategy, which is first and foremost important.

We've been clear with them -- we've been working on this for the last six months.

So, we provided clarity to them, which is important also and we've been having good two way dialogues with them, but at the end of the day our strategy is our strategy and it needs to be executed.

Thank you.

Thank you.

Your next question comes from the line of Michelle Tan with Goldman Sachs.

Great, thanks.

I was wondering if you could give us a little more color on how you plan to emphasize the value message at Old Navy and how that might be changing versus what you did for Holiday?

And then also a question on how the timing would play out on seeing some of that unit cost benefit from deflation, quota restrictions easing into next year.

Is it heavier in the second half or are you already seeing that benefit in the first quarter?

Thank You.

Well, on the Old Navy campaign, I think our Christmas Holiday campaign was a little more value based, it was a little more like Old Navy when we think of its personality.

And that was -- well that was a bridge.

It was done with our agency that we've been working with for a few years and we changed, as everybody on the phone knows, we changed the target consumer, we got a little more focused on what Old Navy brand really stands for, which is as I mentioned earlier, fun fashion for all.

Which is a combination of family, fun, and value.

And when you put those together I think we -- you know we moved fairly quickly to change the marketing vehicle we had over the Holiday.

This campaign starting tonight which is starting tonight, which is with a new agency, is a complete departure than what you saw over the Holiday.

And I think it plays to everything that Old Navy is about.

If we were one dimensional only, then we would have a pure price campaign, if we thought our business was only about family then it would be 100% focused on it.

Or, if it was all about what I think brings Old Navy together, which is this fun component with the personality and the soul of the brand.

I think our new agency working with Tom White and his team have really struck the right balance between the three of those.

There's no question in this environment we would always have a value message at the core, that's what Old Navy is all about.

But I think in this environment we've managed this campaign and it's not just television, it's through the new circular that comes out Sunday, how we positioned our message online, what we're doing to viral communication.

And every -- and so it's really a fully integrated marketing and communication campaign, that's been worked on for the last three or four months.

We felt, as we've talked before, with -- if the product started to be right directionally, which Old Navy's is, if we started to made the right steps in executing at the store level the way we should, if we've got the right marketing message, then we would consider going and spending the money.

In this case here, the last component of that is the consumers willingness to accept the message.

And I think when you are talking about a value player like Old Navy, we couldn't think of a better time to actually go out and reposition the brand under those three pillars of what makes up the brands personality.

And then Michelle, real quick on AUC, we definitely have opportunity in the first and second quarter and you know, we have yet to place orders in the back half, but we think the opportunity is just as great if not greater in the second half.

Okay, great, thanks for the help.

Your next question comes from Brian Tunick with JPMorgan Chase.

Hello, thanks.

I think, Glenn, at the analysts day you mentioned that you were already testing or were about to test some of the Old Navy prototype locations.

So, we were just sort of curious how that was trending and does what you said to the last question tie into the fact that you know, in this macro-slowdown, and most of us would assume that Old Navy would actually be picking up customers and obviously we haven't seen that yet.

Does that sort of fit into your thoughts here.

I think it does Brian, I think I will take the second part first.

No, we are not obviously pleased that given the change in the consumer sentiment that started to show itself in 2008 but obviously really impacted us severely in October.

That Old Navy was still working through its product, mixed challenges and its repositioning.

Because this is, you know, we'd rather not be operating in this environment to be quite frank with you, but seeing as how we can't control that, that is the environment which we have.

Old Navy serves a number of different purposes, well, one it serves is while -- when consumer sentiment does turns down, its job, on top of our portfolio brands, to go out and fight on behalf of the company.

So, yes, I think that we think that that brand is well positioned, I think that Tom has put the necessary steps in place.

It's still not to his satisfaction or mine, but it is much better than it was and I think we decided this is the right time to go out and put the marketing campaign and have Old Navy take its rightful position, which in our -- within our portfolio brands, which is when the consumer is a little down, and more value conscious, it's Old Navy's turn to gain a bigger share of wallet.

In terms of the stores, we've done two in California.

I would characterize them as about 50% to 60% right, but any time you put a new model in place and try to reposition your business, that's probably an average score.

We have three more going in the ground between the end of April the beginning -- end of April and the middle of May.

And I think those will be probably 75% or 80% complete.

So, we're watching, we're learning, big discussions with customers looking at all our metrics including traffic as I mentioned, which is a key metric going forward.

And so far we are pleased with the results we're seeing.

Okay, terrific, good luck.

Thank you.

Your next question comes from Paul Lejuez with Credit Suisse.

Okay, thanks.

A question on expenses, just wondering if it's down $10 million to $30 million that we're expecting in the first quarter, if thats indicative of what we should expect?

And the following quarters, is there anything unusual happening in the first quarter that's preventing more expense dollar savings?

And then second, I just wanted to see what your thoughts are on the size of the Banana Republic fleet.

You eluded to some increasing challenges there.

I'm just wondering with 500 plus stores and the price point, you know, does this environment maybe say to you guys that you should think about pulling back on some of the US Banana Republic stores and close some stores?

Yes, I'll take the first part of the question, Paul.

If w regard to Q1, I guess I would start -- I would start by just emphasizing that we always -- we wouldn't recommend extrapolating savings in any one quarter out to any other quarters, because there's just differences that we'll try and point out when we get there and there's seasonality et cetera But with regard to Q1 in particular, I will start by reminding that we are now beginning to anniversary deep savings that we garnered last year.

So, if you'll recall in Q1 of '08, we actually saved over $90 million in the first quarter.

So, that's what we're beginning to anniversary.

And you know what -- we -- as Glenn said, we are making important investments in our business, so we feel committed to the Old Navy marketing campaign, we want to drive traffic, but at the same time we're balancing that against being really disciplined with our core expenses our HQ expenses and as you can see we are still bringing expenses down overall.

The other areas of focus that don't just show up on that SG&A line, as Glenn mentioned, include of course a continuation of AUC, also savings in the areas of other non-merchandise Procurement logistics and rent and occupancy.

And as far as Banana Republic goes , there's about 450 stores in North America.

If we felt the model no longer had customer appeal, or the segment of which it was operated which is affordable luxury, was being squeezed out, would we be sitting back fundamentally looking at its economic (inaudible) and wondering whether we should have less stores?

I think the answer is, yes.

I think what we're going through right now, as I said earlier, we're disappointed.

I do believe that the team is working on it.

I believe this 30 year old brand is still relevant -- can still perform.

It fits nicely within our portfolio.

It's unfortunate that we have to go down a little bit and do some rework on.

Its not severe, retail is retill, every now and then that you have to make some adjustments.

We're willing to make them, the team's committed to getting it done.

If there are stores inside of the 450, that don't perform, don't fit our strategy, which we've completed 6 months ago, will we consider closing some of the 450, yes.

But to get to the level you talked about Paul, that's not our plans for

Thanks, good luck.

Your next question comes from Kimberly Greenberger with Citigroup.

Great, thank you.

Glenn, at the very beginning of the call you talked about the focus on driving traffic here in 2009, and I'm wondering if you can just share with us some of the ideas you have either by brand or otherwise on exactly how you guys plan to go about with getting more traffic in to the stores.

Thanks.

Thank you, no I think it's a good question.

We -- first of all, we didn't have it all figured out.

We've been starting to get focused this Fall when I think when it became clear to us that we could -- we can be a purist, and we can put phenomenal product out and push our design team and merchandising team and run great stores, and do promotions when it's needed to move through inventory or we can look at our business in a very honest way.

And we've been studying it, particularly people who are new to the business and looked at the last five years, and I think we've been, we have certainly not been a company that's gone out proactively.

And I would say some brands, to different levels, obviously with old Navy being the first, I'd say use the word aggressively.

And gone after and spoken to customers and try to get them inside the four walls of stores.

Then its the job of the store to convert them, and obviously the quality of the product, being brand appropriate and the work of the people working our stores, that's what they own in terms of conversion.

But I would say our marketing when we look at it, we've got to shift our mix.

So, does that mean that brand building marketing, you can take some examples, whether its billboards, magazine advertising, other means we've used before, that we should be shifting some of that marketing.

Put a little bit more more in store into the windows, put a little bit more in to marketing vehicles that actually will get people to react positively and come in into our stores, do more things that are -- that we actually buy into and plan.

Because what I don't want -- I don't want us to be -- is I don't want us to is be a company that is based on -- our promotions are based on moving through inventory as opposed to driving in traffic.

And to be completely fair to out company, I would think the last number of years, anything we did promotional was based on moving through our inventory.

I would like to think that going forward in 2009, any investment we make in our gross margin anything we do in terms of that bucket is going to be based on trying to drive in traffic, and once we get the traffic if the door let the stores and the product do the job of moving through the inventory.

So, it's a bit of a shift for us.

Its taken a bit of time to make sure we have the right people in place, the right accountability, the right metrics its how we're going to measure ourselves in a large way next year, is are we able to get -- one recapture a lot of lost customers we've had before.

But also bring in new customers.

And we believe that some of the work we did this Holiday season to test some of those concepts gave us the confidence to speak today on the conference call and tell you thats something we believe very strongly in, and I think time will tell, we'll -- sort of time will be the judge of our success, but we know this is the right thing to do.

Glenn, any idea on the timing as to when we might see some of those new initiatives take hold?

I think tonight you'll see the beginning of it with old Navy for sure in terms of its campaign, and it's communication and it's much broader than the television I say the television, I'd say the television is the kickoff of a multi-dimensional program and campaign and integrated communication, over the next number of months to speak to Old Navy's target customer and to get people inside of those stores.

But I would say Kimberly, if you walked our stores, I would say you know, end of this month, you'll see all of the brands starting to -- well, still being very brand appropriate which is critical to all of us, critical to the brand presidents, while still being very brand appropriate, being much more proactive in how we try to convince customers across the lease line and these are the brands that they should be walking in to.

And then again it's up to the stores, the signage the marketing and the selling skills of our team to make sure we can convert people inside the store or in the fitting room.

That's very helpful.

Thanks

Your next question comes from the line of Michelle Clark with Morgan Stanley.

Yes, good afternoon, first question, I was wondering if -- or hoping that you could give us inventory positions by division.

And then secondly update us on localization initiatives in your stores and how much more opportunity there is there.

To drive an improvement in the merchandise margin rates.

Thank you.

Alright, I'll start with the first part we actually don't break it out by division, but I'll tell you overall directionally, our principal in buying inventory for all our divisions is the same.

So, we anchor our inventory buys on current traffic.

Thats one of the most important inputs to our inventory buys and we report traffic to you guys every month.

So, its no surprise to varying levels, we've been experiencing negative traffic, so all of our divisions are going to buying their inventories tightly at just a matter of degree how far down.

And on the localization, I'm sure -- I mean, well, Kimberly was asking the right question on traffic -- was a top priority.

And localization is also on our list of 8 or 10 priorities we have for this year.

We may have mentioned -- I'm not sure, at a past conference call that we invested heavily on new inventory system.

Which was pioneered the by Old Navy and is now being used fully by them and all their categories, will be taken up by Banana Republic, Gap and our Outlet business throughout 2009.

One of the benefits of this strategic inventory management system we put into place, is our ability to really do some work we've never done before.

Today we assort by size of store which to somebody who comes from a different retail sector is to say -- to be fair, is surprising.

We actually want assort based on what consumer expectations and demand is going to be.

And this new system will allow us actually to be much more localized, to look at the assortment in a much more different way, whether that's on women's or men's or kids, or baby or temperature related or average household income and will allow us to do that work.

I was recently in a meeting when the Banana Republic team was here, representing all their stores, looking at all their options and basically rebuilding the assortment of store from the ground up.

And that will take place in their business in the Fall.

So, there's been a -- quite a bit of focus and I think that comes with us as a business culturally thinking of customers first, not that we never thought about customers before but I think with a heightened level of focus on customers we are going to sort our stores, we can't do -- use Banana Republic as a an example, we can't do 450 different assortments, that would be chaos for us.

But we can certainly break it down in a much deeper way and a much more fragmented way than we do today, which could be three or four different assortments.

So, that work is underway, I think Banana Republic, Gap, Old Navy and Outlet will enjoy the benefit of that throughout the year.

But we are big believers that we should have been doing this a long time ago.

Our customers have certainly demanded it.

We now have the technology that we made the investment to allow us to do it very easily, and I think its going to be something we're going to get some benefit in the future.

Great, best of luck.

Your next question comes from Jeff Black with Barclays Capital.

Hello, good afternoon, thanks.

So, Glenn, you know, I hear you on the traffic, I hear you on conversion, but do you think this Spring is the kind of product that justifies the kind of spending you're going to do for marketing?

I mean how comfortable do we feel like we finally have product out there that's going to sell and do all the things you wanted to do on comp?

Well, if you're talking about Old Navy, I would say that we have a good enough comfort level to justify the marketing that we're putting in place.

But yes, no, I mean, I think that you're -- if part of the under current of your question is, "do we think this is the end result of the product we are going to have in terms of its brand appropriateness, its styling, it's fashionability, it's final value position?" No, I think Tom and Mark Breitbart are going to join us, they're going to continue to work that product over, it needs to get better.

But we feel that it's made a fairly significant leap forward, and I think the March product you're going to see is going to be coming into our stores a little bit this week and fully next week.

And when we look at the February product in there now, but more importantly, the March product that's coming, yes, obviously we feel confident enough in it to spend the money on marketing.

Now, we also don't think the marketing is a one weekend event.

It's not like as we've done a few times before at Old Navy, running a one day only special to get a whole bunch of traffic to come in this Saturday.

I think we felt as we look at when the marketing will start to get traction, to start it on February 26 and to have it running a parallel course with our product improving, this is the beginning of a, I would say, a long sustained campaign.

So, the answer to your question is yes.

We certainly don't want to be irresponsible.

We've mentioned before in conference calls and -- we think product is improving, the store presentation execution is improving and we get the right marketing message, that we will take those three and test it and decide whether to spend the money.

An obviously in order for us to do this starting tonight, all three of those tests were passed but I don't -- I want to make sure I'm crystal clear, we know the product at Old Navy needs to continuously get better.

So, it's not where we want to end up but its in a position we feel comfortable enough to spend this money.

And then Glenn, just a quick follow on the costs overall, you know, as we get through the year, do we look at operating expenses that are higher or lower given marketing spend and these other investments that you"re talking about?

I know we're a little lower for Q1 but where do we end the year?

Yes, we havent guided to full year SG&A, Jeff, and as you know about 50% of our operating expense structure is store related.

And a big chunk of that varies with sales.

So, it really depends where the view ends on sales on that store related piece of where the expenses goes.

On the non-store related expenses, we are absolutely committed to tightly managing those and we're appropriately decreasing those, and I think we built some credibility in that area during 2008 and we're going to continue on that path.

Then there is the other bucket that is marketing.

And as -- you know, we've been talking about, we are committed to driving traffic and using marketing as one vehicle to do that.

So, long as we feel like we are getting a return.

So, we will be monitoring that closely including this campaign that's running in Q1 to determine how much we will continue investing in marketing as the year goes on.

Alright.

Fair enough, good luck guys.

Thank you.

Your next question comes from the line of Stacey Pak with Equity Research.

Good, hello.

Just a follow on that and then I have another question.

Just on the SG&A, I mean so, if we were to assume that sales kind of stay as they are, i.e., it doesn't get a whole heck of a lot better.

Is the level of SG&A reduction you're achieving in Q1, you know, the same type of reduction you would be able to achieve for the year?

You know, again, assuming that sales kind of stay as is.

And then my second, real question, is Glenn, you talked about being pleased with the Gap brand and I guess, you know, not to be rude or anything but I'm puzzled a little bit because the comps at Gap brand have been just about as bad as Old Navy and Banana.

So, I'm wondering what statistics you are encouraged by?

Like, what are you seeing that I'm not seeing?

And on the Old Navy, how much testing did you do on this marketing?

How confident do you feel it's really going to reinvigorate the brand?

How did you test it?

And do you think it will drive the traffic?

Thanks.

So, Stacey, I'll try and break it down again to try and be helpful.

On the store related sales we are going to do our very best not to deleverage store payroll, store other expense.

We've been successful with it in 2008.

Honestly it gets harder, because the fixed piece will become larger relative to the variable piece as sales have come down.

But that is absolutely our objective to continue to manage those expenses so they stay in line with sales.

Marketing, as I said it will depend on the success of these campaigns, how much we want to continue to invest and we'll try and be helpful each quarter directionally about where our head is at and how we evaluated the spend.

With the non-marketing and non-store, we will manage that tightly and down.

And on the other two questions on Gap brand, one of the things we've been doing is we have been looking at our business on number of different dimensions.

One we looked to Canada, where the economy is no where near as challenged as it is here in the US, but the product is identical.

And this is not the only measurement of how we're measuring our business.

And no question, from a comp perspective, we look at our business and we know we have a ways to go in the order for me to put a fact based number behind what I said earlier.

I think that we're looking at it from a total product and how its on brand and how where we see the momentum building with a team that's in place.

But when we go to Canada and look at a market that has not been as severely affected, we are actually very impressed comparatively speaking to the US, about how that business is doing and how that product is resonating.

And I can make that case a little bit in the UK and a little bit in Japan also, where the product is 70% or 75% the same, except for some localization on fit in a few selected categories that are right for the markets.

So, there are three or four other tests we would put into place in order for me to come forward today, and we do it internally too and say look, does GAAP still have more innovation, more creativity, more incubation work to need to do to make sure that they are getting their stride and getting people to come in and see that brand the way we want it to be seen.

They always have more work to do.

I think the best brand in the world has more work to do.

But I think we are making -- I think we have a very good foundations established and the fact that teams been there for two years I'm starting to see the product not only being designed merchandised but being presented in a store in a way that we are starting to feel quite comfortable with them and then you have these other metrics I referred to that we look at.

In terms of old Navy, definitely did testing.

I believe in it.

But I'm not -- I believe more in us understanding the brand, and making sure we feel very comfortable that this marketing campaign is appropriate for the brand, but yes the agency we use which is Crispin, did some very strong testing that resonated very well, it's one data point.

What matters to me is not, again, day one, when the campaign hits but over a sustained period of time as we continue to get the messaging out, using this marketing vehicle to talk about what makes Old Navy special, fun, fashion and family, that we will be able to some see improvements in his recent comp trend.

So, good testing, good results and you know, this will -- we'll get a pretty good read over the next -- I'd say 30, 60, 90 days.

Okay, thank you.

Your next question comes from Janet Kloppenberg with JJK Research.

Hello, everybody.

A couple of questions.

First, on the inventory, Sabrina and Glenn, are you comfortable with your inventory?

I mean, I wish I could project that your comps were down 6%.

But my guess is that they're down more than that.

And generally you've been keeping your inventories, very much in line with your sales trends.

And if they're going to be down high single digits at the end of the first quarter, I'm wondering if that's, you know, some sort of indication of how we should be thinking about topline going forward?

And then Glenn, I wanted to ask you a question about Old Navy and the marketing decision.

Generally we see a marketing program we instituted after the product has been proven.

And if you feel that Gaps product is doing to well and is much more on solid ground, I was wondering why you made the decision to invest in Old Navy when it might be early?

As opposed to Gap, where there's been a solid team in place for two years and you've seem some measurable success?

Yes, I'l start with inventory, Janet.

So,we are very comfortable with our inventory.

Inventory is obviously a very key lever in our business.

And all of our inventory buy decisions are -- take in after a lot of thoughtfulness of the teams work and part and our view of what's happening with our business.

I'll tell you, you know, we anchor our buys on our current traffic because we view that as a proxy for customer demand and more or less you know, that has served us well.

The other really important metic that we monitor when we think of our inventory buys are obviously our inventory turns.

So, again you know, signs that we'd want to either buy up would be that our turns were speeding up a lot, or signs that we're buying too much ahead of demand, would be our turns slowing down.

So, at this point we feel really comfortable because turns are holding fairly steady.

A little better in some places but holding fairly steady.

The other important metric is cost sells at REG, because we definitely want to walk that tight rope where we're giving our customers an opportunity, especially in a recessionary environment, to buy value oriented, to offer promos, but we don't want to start to deteriorate too much our cost sales at REG, so that's a important metric.

And then finally, markdown margins we watch, because certainly if we're carrying too much inventory, thats where you see -- we have seen historically that your margins really get whacked.

And so far, like what we've seen in 2008 is our markdown margins were actually one of the levers that really enabled us to deliver these healthy merchandise margins, so, we're comfortable.

What do you mean -- Sabrina?

Yes?

Excuse me for one second.

What do you mean by that the margin you made on markdown was a healthy one?

Therefore it's not so bad to have some markdowns around?

Yes, well certainly in retail it's not bad to have some markdowns around.

But what's important is that we balance our cost sales at REG, which we also want to be healthy, right?

We want to do a healthy amount at regular price but when we go to markdown, we want to make sure our markdown margins are healthy.

And in 2008, they grew -- they were healthy and they were a driver to our year-over-year improvement in merchandise margins.

And why Old Navy over Gap, I think a couple of things.

One is we stated earlier, you know assuming that we're going to be in the value pressure were under right now, from the consumer for a minimum of the next 12 months, you know, we are -- we believe and we've not been happy of the fact that -- as I mentioned earlier, the one brand that have -- that and our Outlet business, that should be called upon during these times to go out and compete on behalf of the company.

Get more value, sort of get volume, get more customers, and go out and serve a purpose, that's the reason why we have a multidimensional brands inside the portfolio, that we felt -- and we certainly would never go and we're not talking about hundreds of million of dollars here in this first quarter or first half, we would feel that we are not taking advantage of the opportunity in the marketplace right now.

We feel good enough about the product.

My point is that Old Navy was in a place that we were not happy about 12 and 9 months ago.

There's certainly been a big swing to the product we see today that is very much appropriate.

We've been talking to customers a lot.

We've been getting some reads, as I said earlier, January was obviously one of the those horrible months for us to get a read on.

But we did the best we could.

Thought we come up with a very good marketing message and it's the brand that we have to reinvigorate first, it doesn't mean that Gap is not getting any marketing, its just not getting a fully integrated campaign.

A lot of people measure marketing by television, so we've said before will Gap every go back to television?

Possibly.

Do we feel that the media and the mediums they're using right now to communicate message is appropriate for that brand?

It is.

But, right now we recognize the missed opportunity with Old Navy, we believe that we're in a position now with this campaign to get it back up and change the trajectory of the comp that it's been on.

It doesn't have enough inventory to positive comp out of the gate but change the trajectory is key for us and allow it on behalf of the total company, to go and participate in this increasing value segment.

Okay.

And Glenn, could you evaluate for us the contribution or success level of Patrick Robinson and Todd Oldman to Gap and Old Navy respectively?

Janet we are going to limit it to one per caller.

So, Sabrina and I are available afterwards -- .

Okay, thank you.

And then we have one last time for -- we have time for one more caller operator.

Your final question will come from the lind of Richard Jaffe with Stifel Nicolaus.

Hello, thanks very much, guys, and we say Stifel here.

It's been a very helpful call and obviously you guys are trying to do a lot in arguably the toughest retail environment.

And I'm wondering how -- and you touched on this, how you sort out the results, the good news from this very overwhelming environment.

And if you could talk through just a -- brand specific, how you are seeing the good news amid all the, I guess, the tough economic news, the weak traffic nationwide?

And how you soft of manage your responses to I guess, the glimmers of hope that you find in the product mix?

No, I think that you've hit on a really good point.

In an environment like this -- well, first off without being overt in our celebration, I think we will probably take all of this afternoon, maybe a little part of tomorrow morning, to be thankful for the fact that the business and the people in the business performed at the level they performed last year.

You know, I think that people need to be recognized inside our company.

We're not looking for any fanfare, because part of getting to the numbers we got to -- part of the way there, was that some people left our business.

And as we tightened our belts there was some impact on the people.

So -- but -- we will take a little bit of time to say, "You know what ,in this tough environment we were able to grow EPD by 28%."

In this very challenging environment where a lot of companies were in the high, high, negative double digit performance in their EPS and their net income, we not only grew cash-flow by $1 billion but obviously had -- have -- now have $2 billion on our balance sheet.

So, its recognized and internally that we have a very strong foundation, is first thing that I always I bring people back to.

And then you're absolutely right, I mean, its one of the small wins.

Business ever business not just ours -- there's no home runs now.

You've got to find out the small wins -- the little moments in which you do really well, and I think that I could take the better part of the rest of the afternoon to answer your question, but I would go through every single brand and there's a little glimmer of hope and there's a small win every single week in every single one of our brands.

Our job, as the senior people in the business, is to put those together to actually start getting some momentum in the business.

So, step one for us in 2008 was to prove to ourselves, under these conditions, we can make the tough decisions, and they were tough decisions, without jeopardizing the company and its long-term position for the future.

What I like about our position in 2009, is given what we did in 2008 we gave ourselves some flexibility.

We're now -- we're not -- we're now not in a position where we're making decisions to generate extra cash.

We're not in a position because our balance sheet is under stress.

We're not in a position because we have $2 billion or $3 billion of debt.

We are in control of our own destiny.

And trust me there are positive signs in little corners and little pockets all over our company.

But at the end of the day, we do not want to be known as a company that can just single handedly manage AUC, SG&A, Rod, distribution cost, inventory -- that's not what we signed up for.

We did what we felt we had to do in 2008.

And now as we turn the page in 2009, we're not going to forget about those, that was all good work and we certainly are not going to go back to where we were and have a very heavy cost business.

We made some tough decisions and now, we're much leaner, battle tested, and cash rich.

And now, we've got to prove that we can bring customers insides our stores and start driving the topline of our business and as I said earlier in my opening comments make smart investments to position the company for the future.

Athleta for the future, more investment and online for the future, franchise business for the future, international business for the future.

But the core North American business has to start performing and all the brand presidents know that.

They don't have to listen to this call to be put on notice, they know very clearly from me every day they have to get that business on a top line and incremental gross margin dollars going because none of us signed up just to be in charge of managing SG&A and cost.

Step one, good, step two is the one I'm most focused on now.

Thats good to hear, I agree, thank you.

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

As always the investor relations team will be available afterwards for further questions, thank you.

That concludes today's conference call.

You may now disconnect