蓋璞 (GPS) 2010 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen.

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

first quarter 2010 conference call.

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

(Operator instructions).

I would now like to introduce your host, Marc Webb, Vice President of Investor Relations.

Good afternoon, everyone.

Welcome to Gap Inc.'s first quarter 2010 earnings conference call.

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

I'd 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 Gap Inc.com as well as other statements that express our expectations, anticipation, beliefs, estimates, intentions, plans and forecasts.

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

Information regarding factors that could cause results to differ can be found in our annual report on Form 10-K for the fiscal year ended January 30, 2010, 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 May 20, 2010, 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 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'd like to turn the call over to Glenn.

Thanks, Mark.

Good afternoon, everybody.

Let me just make a few comments before we hand over to Sabrina, who will give you the financial update for Q1.

First off, in general we were pleased with their performance in the first quarter.

One of the metrics we have been looking at a lot more closely in the last year or so is what does our growth like on the top line.

So in the third quarter we flat comped, in Q4 we were plus 2 and in Q1 of 2010 we had a plus 4 comp.

So going in the right direction; we felt good about that.

With that said, it's still a very volatile consumer environment.

I'm finding it personally, having been a retailer for over 20 years, that it's just very difficult to predict patterns, week to week, weekday to weekends.

Most importantly to me, though, is we are able to take that improving top line and really leverage the business.

We've been talking a lot about that here internally, and once we start turning our attention towards top line, how do we maintain that discipline we worked so hard on, so getting 290 basis points of leverage on the operating margin line was important to me.

I'm actually pretty proud of the teams.

Getting off to a good start of the year is critical in any business, so I'm glad that we came out, had a good performance, delivered on our expectations.

I think that sets us off well emotionally for the rest of the year, to get off to a good start in the first quarter.

There's certainly a few areas that I'm focusing on as I look forward to the rest of the year.

I am looking for a little more intensity when it comes to our value proposition messaging in the business.

I'm looking for a bit of a stepped-up effort in our business around our category strategies and the dominant position we're going to take within brands on key categories.

Lastly, I'm looking for the teams to show some improvement on the consistency of our product delivery.

If we can get some traction on those three key components along with a culture of discipline, I think it will set the business up well for continuing to perform at a respectable level going forward.

Let me now turn and give you a quick update by brand.

Old Navy had a very good first quarter, particularly in kids and baby.

And I think we've spoken before on this call that the way we look at Old Navy is that that key customer provides for her family first and then buys for herself.

And the kids and baby business under great leadership has really had a good quarter and a market share gaining quarter.

The new stores -- we are doing the remodel stores we are calling Project One.

100 of them got done in Q1.

But, in fairness, the majority of those opened on the last weekend of the quarter.

So we're not going to see the benefit of the repositioning of those stores until the second quarter.

Some work is being done by Tom Wyatt and Nancy Green right now to tighten up the assortment a little bit.

I think their view is the assortment probably got a little too broad over the last six months.

There's some good work going on there which I'll see in the second half of the year.

And everybody at Old Navy is very excited about our new CMO joining us, Amy Curtis, a very talented person, great resume, great experience.

And I think she's going to make a real difference in the position of that brand to our consumers.

At Banana Republic, Julia and Simon are working well together, seeing some definite benefit in products and the key categories they're looking at, seeing that show up in pants and in sweaters, and just two examples of categories they are very focused on.

Our new store remodels for Banana Republic are doing quite well.

I'd encourage everybody who hasn't seen them to go to Soho.

I was just there two weekends ago for the relaunch of that store on Broadway.

It's a beautiful looking store, doing extremely well on all metrics.

And one key win, I would say, in the first quarter for Banana Republic is in the clearer definition of the Heritage and the Monogram line.

I've always been a fan of those lines.

I think it differentiates Banana Republic.

And Jack and the team have done a really good job, and we'll see that more and more coming to market as we look further into the year.

At Gap, there's a lot of work going on with the team.

We talked last quarter about some reshuffling we did of executives, and we have very high expectations of that brand to start showing some better traction and some improvement in its business.

I am pleased with the rhythm I'm starting to see in denim, on the heels of 1969 coming out every month with patch and repair, white denim.

This next month is bleached denim.

I think they're really getting how dominant we can become in that category and start to build momentum on it.

Speaking of 1969, I should also mention that we opened our third 1969 store, which is obviously a very strong denim expression for us.

And we're learning in those stores, learning how to merchandise, learning about fixtures, learning what customers expect from a brand like 1969 denim.

We're taking those learnings and we're putting them back into the core Gap stores.

As a matter of fact, we're going to be spending a little bit of capital on a couple hundred stores which will be opened up by the end of July to coincide with anniversary of last year's launch of 1969.

And we just announced last week that Rosella Giuliani is going to join the company.

Rosella is the senior merchant and designer over at Seven For All Mankind, phenomenal denim expert.

And we're going to move our whole denim team from New York over to LA.

One of the strategic decisions we made was to move the team under Rosella's leadership, working with Patrick Robinson and working with Pam Wallack, to bring denim to the next level inside of Gap stores.

That team is looking forward to the relaunch of black pants, which will be in our stores on July 26 and will be marketed at the end of August.

I think we're holding that team accountable to try to get the same kind of performance on the black pants we saw in denim, use it as a springboard to not only buy loyalty but get new customers into their stores.

Let me just give you a quick update on our international business.

Everything is progressing very well in China for a late fall opening of the Gap brand in the Chinese market.

I've seen some very good progress with the team on strategy, definitely some thoughtful ideas when it comes to our value proposition.

And really, the real estate team is starting to get good traction.

Banana Republic opened up its third store in Europe, Covent Gardens in London.

Its early indications is it will be as successful as the first two, so we are very pleased about how Banana Republic is progressing.

A couple more stores to come this year, also in London, and we're looking forward to opening up in Paris in the early part of 2011.

Our Italy launch is progressing very well, looking forward to our Milan store openings, both Banana Republic and Gap, late fall of this year.

And we're starting to see some potential opportunity in Rome.

More about that later on, but that's more of a 2011 opportunity.

Online launches are on target for Canada and Europe, as we talked about in the last conference calls.

They're going to launch in the month of August.

Our global outlet team has been very busy this quarter adding new stores in Canada, new stores in Japan, new stores in the UK, testing a few new concepts.

So I'm pleased about that.

And they have put together an excellent strategy for China.

Lastly, we will be testing a store, brick and mortar store, for Athleta later this month.

It's a test, but as I've indicated before when we bought Athleta, there was a number of steps we had to get through -- integration, putting them onto universality platform.

This is the next evolutionary step for Athleta.

We feel very good about the performance we've seen, well ahead of our expectations in the athletic business.

And this is a natural next step.

So that's an update on Q1.

Let me know hand over to Sabrina to take you through the financial update, and then I'll be happy in a few minutes to answer any more questions that you may have.

Thank you, Glenn.

Good afternoon.

For those of you participating via webcast, please turn to slide 4.

Over the last few years we've worked hard to strengthen our operating model.

Our merch margins are at 10-year highs.

Our expenses are tightly managed.

Our operating margin is expanding in our earnings in free cash flow are growing.

Now, as we focus on driving sales, it's our intent to continue leveraging this operating model.

Doing so enables us to make investments for the future while delivering earnings growth and distributing cash to shareholders.

Our first quarter performance represents good progress against our goals.

Here are some highlights for the quarter.

Comp store sales were up 4% with all North American divisions posting positive comps for the quarter.

Gross margins were 42.1%, up 250 basis points.

Operating margins were 14.2%, up 290 basis points.

EPS grew 45% and we generated $222 million of free cash flow.

Please turn to slide five for our earnings recap.

In the first quarter net income grew by 40% to $302 million, and EPS was $0.45 versus $0.31 last year.

Included in these results are about $0.02 of benefit related to the favorable resolution of tax issues in the quarter.

About $0.01 of the benefit is reflected in interest, and the other penny is reflected in the tax rate.

Please turn to slide six, sales and gross margin performance.

Our strategy is to drive sales by selling more units while maintaining the healthy margins we've achieved.

When we do this, rent and occupancy should leverage and gross margin rates should expand.

In Q1 total sales grew 6% to $3.3 billion.

Gross margin expanded 250 basis points to 42.1% with merch margins up 160 basis points and 90 basis points coming from rent and occupancy leverage.

Gross profit dollars grew by 13% to $1.4 billion.

Looking at inventory on slide seven, inventory dollars at the end of Q1 are up 10% to $1.5 billion.

After four years of Q1 inventory reductions, we've begun making targeted investments back into key categories like denim.

In addition to supporting our goal of growing sales, these investments built in-stock levels to improve the customer experience in our stores.

And we've also been reducing square footage.

These actions combined result in inventory dollars per square foot up 12% this year.

This compares with Q1 2009 inventory per square foot, which was down 12% on top of Q1 2008, which was down 17%.

Turning to slide eight, operating expenses -- in Q1 we continued to demonstrate cost discipline.

Despite investments in growth, we were able to leverage operating expenses by 50 basis points.

Operating expenses grew $41 million to $927 million.

Marketing grew $17 million to $113 million, driven by Old Navy and our online brands, Athleta and Piperlime.

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

As I mentioned earlier, we have been reducing square footage, primarily at Gap and Old Navy.

We ended the quarter with 3085 stores and net square footage was down 2% compared to Q1 2009.

We opened nine stores weighted towards international and closed 19 weighted toward Gap brand.

First quarter capital expenditures were $107 million.

Regarding cash flow on slide 10, for the quarter free cash flow was an inflow of $222 million compared with an inflow of $139 million last year.

We repurchased 14 million shares in the first quarter for $296 million, and we ended the first quarter with about $2.5 billion in cash and short-term investments.

Now I'd like to discuss our outlook for the rest of the year.

Please turn to slide 11.

As I said, we plan to drive sales growth while maintaining the healthy merchandise margins we have achieved.

Doing so should leverage rent and occupancy costs.

Going forward, the opportunities for further gross margin expansion will come primarily from broad leverage.

The primary driver of sales growth is increased unit sales.

Similar to Q1, Q2 inventories have been declining since 2005.

In order to improve sales productivity and drive costs, we are prudently building inventory in low-risk categories.

We expect Q2 ending inventory per square foot to be up in the low-double digits, similar to Q1, and that compares to negative 14% in Q2 last year and negative 17% in Q2 of 2008.

Moving to operating expenses, we expect the investments in our growth initiatives to be higher in Q2 versus Q1.

In addition to remodeling another 80 Old Navy stores, we are now beginning to incur expenses related to the launch of our online businesses in Canada and Europe, and the first stores in Italy and China.

We expect our base business to continue to leverage operating expenses as sales growth.

However, total operating expenses including growth investments may slightly de-lever in the second quarter.

With regard to occupancy costs, still expect leverage on positive comps.

But, given the increased investment in growth initiatives, the amount of leverage may be lower in Q2.

We are very pleased with our Q1 performance, and our outlook for the year has improved.

That said, our biggest selling quarters are still ahead of us, and volatility remains in the economy.

We are raising our estimate for full-year earnings per share, which we now expect to be $1.77 to $1.82, up from our previous guidance of $1.70 to $1.75.

This guidance includes the dilutive impact of our growth initiatives and implies double-digit EPS growth.

The following full-year guidance metrics remain unchanged -- depreciation and amortization, about $550 million; effective tax rate, about 39%; operating margin, about 13%; capital expenditures, about $575 million; new store openings, about 65; store closures, about 110; net square footage decline, about 3%.

In closing, we are pleased with how we executed against our strategies in Q1 and are encouraged by the progress we're making to improve top line across all our divisions.

Thank you, now I'll turn it over to Mark.

Operator, that concludes our prepared remarks.

We'll now open the call up to questions.

Everyone, we'd appreciate the menu questions to one per person.

(Operator instructions) Michelle Tan, Goldman Sachs.

I was wondering if you could talk a little bit about the inventory growth.

It's higher, I think, than the mid-single digit you talked about last quarter.

I'm wondering what the driver is and then any color on particular categories that you are investing behind.

Let me start with maybe why overall inventories are higher and what we are investing in, and then I'll tell you about the delta between what we expected earlier in the year.

As I said in my remarks, I think the most important thing is to remember for contacts is that, probably unlike most of our competitors, we have been cutting inventories for four straight years.

So if you look at our 2010 ending inventory up 12, it's actually still down about 30% from like 2005.

So from any absolute perspective the inventories are really still quite lean.

The other driver to the increase is the fact that, as we are trying to improve sales, have positive comps, our square footage, as you know, is down.

So if you think about the math of that, to drive sales and a positive comp when square footage is down, mathematically, you're going to want to have more inventory per square foot.

So that's the second lever.

Then also, because of the four years we have been bringing inventory down with now some momentum behind us, we really want to make sure that we don't disappoint our customers as they are coming back into us.

And so we're purposefully investing in some categories to be in better in-stock positions.

So the biggest categories are going to be denim.

And then like, for example, our fall launch of black pants is another category that we want to get behind.

And we are actually incorporating lessons from last year.

As you all might remember, when we launched denim -- and that was quite a successful launch -- we ended up being probably too lean, in hindsight, especially in some styles and in that smaller size, as you might remember.

So when we launch black pants now, we are purposefully going, erring on being on the heavier side because we don't want to disappoint our customer.

We feel fine about that investment because we're going to stand behind denim and black pants for some time.

It's not a highly liable fashion item.

So we feel like, from a risk perspective, it's a really good bet to get behind that for the black pant launch.

With regard to the delta between where we thought it would and where it actually ended, that's actually mostly an in-transit issue that we are just heavier bringing in new goods into May.

Mostly it's Old Navy new goods versus LY, the in-transit is heavier.

We were pretty lean going into summer last year, so we have quite a bit of fresh goods coming in this year.

Kimberly Greenberger, Citigroup.

Could you just remind us what your operating term margin goals are for the business?

And what do you think are the two or three key drivers that get you to that goal over time?

We actually do operating margin guidance one year at a time, so we're definitely looking for expansion in 2010 from 2009; we said about 13%.

From a longer-term perspective, do we feel that there's anything holding us back from solid mid-teens?

No, we don't.

We feel like we're on a good path.

We are always trying to balance short-term driving toward that with our long-term goals of investing in growth initiatives, so we're always going to go for expansion but with an eye to investing in long-term growth as we do that.

So we'll give you more explicit guidance one year at a time, but we feel good about eventually getting to mid-teens.

And then I'll just turn it over to Glenn -- oh, and the drivers, really quick, about expansion, are going to come from gross margin.

So we've talked about the fact that, if we are successful with growing sales, our rod is the primary lever to expanding gross margins, so that's up one big lever.

The second big lever being we are going to sit very disciplined on operating expenses.

And as top-line sales improve, that, over time, also has room to leverage.

One thing I would add is that we've been studying and dissecting the operating margin for Zarra, H&M, Uniglo, and for the most part in the last few years, they have been perennial high teens, in some cases low 20s operating margins.

And we've been spending a lot of time with the team here.

We're not saying their economic model should be our economic model.

We look at INDITEX in 75 countries.

You look at H&M in 40 countries, operating.

And as we put the emphasis in the latest investments we've been making, particularly in outlet and then online, which are high return on sales business as for us and high ROIC businesses for the Company, I think trying to find the right mix of our portfolios as we go internationally and some other decisions we want to make based on some lessons we've learned from them and how they look at their business, how they approach their business, given our size and our multiple brands and a lot of similarities between us and INDITEX, we've been using that as a bit of -- let's call it an operating margins north star within our business to say, how far can we go and what's structurally different between our business and some of these three other companies, global companies who we admire, and why we couldn't take steps in that direction?

So, that said, that's putting a number out there.

And that's not a number we are committing, but there's a lot of lessons to be learned by those three other companies.

Betty Chen, Wedbush Securities.

Congratulations on a great quarter.

Glenn, you alluded earlier to the volatility in the marketplace.

I was wondering if you could give a little bit more color around that and whether that changes your philosophy around some of your value messaging or where you want the team to focus on in terms of achieving the market share goals that you have laid out this year and whether that has changed any of your targets in terms of the amount of market share you would like to regain or the buckets that you'd like to chase after.

There's definitely no change in the market share approach.

But the volatility, I can't believe for a second, is unique to us.

So it's a market dynamic that's going on.

What I tried to say my opening comments is, given the amount of years I've spent in retail, it's not often that you look at a normalized week -- let's take this week -- and look at a business that you do certain sales on Tuesday.

There's a natural, predictable build from Tuesday to Thursday.

Some of those predictions, the history we've had in our business for many years -- on some weeks it goes counterintuitive to what we thought was going to happen.

So what we've done is recognizing that maybe that's the new normal, maybe that Memorial Day weekend in 2010 is not going to trade the way it did in 2007 because we are in a new environment in terms of how the consumer responds.

All we've done, which I think we have a bit of a head start versus other people, maybe we're a little more committed to doing this, is as we lay out by brand and by channel our marketing and merchandising plans over a 52-week basis, we've worked into those enough flexibility that we can make very quick decisions that we couldn't have made a couple of years ago.

And that can be up or down because of the ability for us to now read the business, stay to the course -- which is ideal.

Any retailer would say if it was 100% predictable and you could just stick to your plans, that's the perfect scenario for all of us.

And given the fact that's not reality, we have worked hard here to make sure that all of our plans have enough flexibility to make good decisions very close to key dates, very close to key seasons, and the teams -- I'm very pretty proud of what they've been able to accomplish.

It's a new way of thinking for us in general.

It's probably not a new way of thinking for some other retailers and other sectors.

But definitely I would say it's a new way of thinking for people in specialty apparel.

So we've been gaining experience with that, learning lessons the last couple of years, and now the notion of contingency, what people ask about all the time is, I think, it's much more fluid between our plans and what option do we have, how close to the actual date do we make those decisions.

And that's just something we've had to adjust to.

It's fine.

The market is the market.

And either you can fight it or you can adjust to the circumstances that we're dealing with, and we've chosen to adjust to them to make sure we make good decisions every single week and every single month.

Brian Tunick, JP Morgan.

I was wondering, on your merchandise margin commentary as we go through the year, are some of those comments related to maybe where historical markdown rates might be versus today, or is there something happening from the sourcing side?

I'm sure everyone is focusing on that.

And then also, does your guidance includes the $0.02 benefit from Q1?

I'll take the merch margin comment first.

Really all we're highlighting is the fact that we've made tremendous progress over the last few years on merch margin.

If you just look at Q1 alone, we are up almost 600 basis points from just our 2007 merchandise margin.

So in this environment, you just don't want to over use that lever.

Now, we're going to continue to look for opportunities in merch margin.

But what were signaling is, given that we are at certainly decades-high merch margins, if not all time high merch margins, that's a bigger opportunity in expanding growth margin really comes from rent and occupancy, for the simple reason that during this period that we have been really marching up on merch margin, as you know, our rod for the most part until recently has de-levered.

So in contrast to that merchandise expansion, rod has de-lever 250 basis points full year 2009 compared to full year 2005.

So that's quite an opportunity for us.

Again, our strategy, given that we have achieved very healthy margins, is more around less sell more units at the healthy margins, get top-line sales up and make sure we start leveraging rod.

So that's the primary focus, even though we are not giving up on merch margins.

So that's the first part.

With regard to guidance, yes, we kept our effective tax rate at 39% for the full year.

We just got a benefit from these resolutions in Q1.

So the way to think about that is it's almost like a timing shift.

We are getting more of the benefit in Q1, and the tax rate comes up a little bit in the out quarters.

So the full-year guidance definitely incorporates; that's just the timing shift.

Basically, is it sourcing, or is it markdowns that present more of a challenge as we go through the year?

With regard to our markdowns, we still think we have an opportunity there.

We have been doing really well with markdown margin rate.

So, as we shifted into some healthy rate price selling, more in reg and promo, we just don't have as much pressure on markdowns, so we've gotten great markdown margin expansion.

That's not necessarily over at all.

With regard to average unit costing, we've made great deal of progress in 2008 and 2009.

We're still doing just fine in 2010, although we flagged long ago that that definitely would be moderating as the year went on.

Jeff Black, Barclays Capital.

Congrats on the good quarter.

Not to harp on it, but it's the first time we've seen inventory rise like this.

I hear what you're saying, but could you give us a better explanation of just how much of this is devoted to the black pant initiative, how much of the build is devoted to clearing up in stocks or bringing up in stocks where you need to, and how much of the build might be devoted to initiatives at Old Navy or the other divisions?

I'd say, broadly speaking, that probably the bigger chunk of it is devoted to making sure that in key categories that we are going to stand behind for a big chunk of time, that we are in better in-stock positions.

That's the big chunk of it, whether it's Old Navy or whether it's Gap, that's really going to be the primary piece of it.

Glenn, do you want to talk about in-stock?

I think we've looked at our business probably a little differently than we did historically on -- by brand, looking at our customers.

And we've spent a lot of time even during the depths of the recession where we were mostly applying very rigorous, disciplined inventory management, not quite understanding where the customer was going to settle.

Now that we are at least at a different period and maybe we are no longer having to deal with the thought that maybe things are going to get worse and we are at a bit of a standstill right now in terms of the economy and the consumer, we did some previous work a year ago, which was what are needs and what are wants that each one of our customer has within each one of our brands.

And I think when it came to needs we really felt and did the analysis that we were not satisfying them.

We were under-delivering.

And if you put your customer management hat on only, we were finding that a lot of people were telling us that they were just disappointed when they came in for certain things, and we hit some of the categories today that Sabrina talked about.

We were just not delivering for them 52 weeks a year.

And that's, for me, in particular, having come from a different industry, that's for a disappointing.

I kind of understood it in part of 2008 and 2009, when we're making some very decision big decisions on the fly and trying to figure out exactly where the consumer was going to land -- but now, while the picture is not crystal clear but clearer, we decided to embark on -- started with what categories do we want to really go for and by brand?

Do we want to have gain share and be more dominant and make sure the inventory goes into those categories first?

It just so happens as you look at inventory, and inventory is a mix of different products, it just so happens that a lot of the categories that we are choosing to be strong in within brands have a high AUC to them.

So when you mix -- I'm not saying this is the case.

But hypothetically, just do the math and say the units were flat.

If you said that, if you just do it by dollars, you'd mix out on different AUC categories.

You're going to get a natural blip.

Those are categories we feel strongly about.

You heard Sabrina touch on some of them.

And denim, in particular, is a category we want to be very strong on in Gap and in Old Navy, and women's pants in particular at Banana Republic.

So as we figured those things out and made the decisions, we came to the conclusion we're going to make the right call for the customer.

We're going to try to minimize the risk to the business, but we are following this path of making sure we don't have any negative aura anymore on our brands as being a brand that maybe cannot deliver on these needs.

Dana Telsey, Telsey Advisory Group.

With the solid start to the year that you have and what you had mentioned at the beginning of the call, can you expand on some of the key initiatives, for example, on the value proposition messaging?

Does that mean adjusted opening price points or more promotions or the stepped-up category strategies?

Has that enhanced advertising for each brand?

And then is consistency and delivery -- what adjustments are being made to speed to market?

I'll start with the value proposition.

What I was trying to articulate is now -- a little bit of Jeff's question, too -- as we've worked hard in the business of saying where are we going to dominate and go after share because I may have mentioned in a previous call.

To have an arbitrary strategy that says we're going to gain market share means, at least in my case, means nothing to me.

It's what do we believe we can dominate on?

What categories can we use to elevate the overall business by focusing on those?

So, hence, from that you get what is the value proposition of the business.

And that is not necessarily strictly looking at opening price points and promotions.

It might just be more about frequency.

It might be more about how we actually speak to customers and all the different tools we have to communicate this is great value.

I'll give you an extreme on the other side.

Banana Republic is positioned in the affordable luxury business.

One of the tools they've just started using, I believe they should really step it up and I suspect Jack will do this is inside their store they have a number of products they define every single month as the new price of luxury.

So they are taking items that I think a lot of our customers who might go between some luxury brands or department stores and frequent different types of brands and value positioning within their shopping habits -- they are now looking at saying, well, if you know what a luxury item costs in key categories, what's the new price of luxury?

How do we go out and take those, buy into them, put a great price on it and actually show the value that Banana Republic brings?

That's on one side of the scale.

People think about value proposition, they might always think about what does that mean in Old Navy in terms of hard-nosed, aggressive, everyday value pricing?

That, by the way, happens to be true.

But also across all of our businesses, when people come in, knowing the customer we are going after, how do we define that value proposition for them, knowing that they frequent a number of different brands or different sectors within retail?

So we've been working hard on that front.

In terms of speed to market, we've been making some steps, probably not enough to my satisfaction over the last 15 to 18 months, on the supply chain, from the back door of the store -- sorry, back door of the vendor to back door of the store, and then upstream from the design decisions from our teams in New York and here in San Francisco, all the way to the actual placement of the PO.

Over the last six months we've made a lot more inroads on that front.

Old Navy led it 2.5 years ago.

Now we are seeing that Gap and Banana Republic and our outlet business and our online business and our global businesses have really adopted the fact that we need to become a lot faster, much more nimble.

And some of those benefits that we hope to get in the fourth quarter of this year, but there is a bit of a mind shift going on.

If we can do this to working with our existing vendors and that being fast and moving quicker to decisions and taking out significant amount of weeks from design to the back door of the store doesn't mean that your aesthetic has to be fast fashion.

That's speed as a process; your aesthetic is your aesthetic.

And I believe that everybody here -- in fairness to them, we didn't have a lot going on in the last couple of years, trying to steward the business to where it is today.

But now that we're in a different place, we believe we can take on this initiative and work it into each one of our brands over the next number of months and years.

Jeff Klinefelter, Piper Jaffray.

In terms of store rationalization work and consolidation that you're doing, you articulated this strategy a couple years ago very clearly and have been making some progress.

It sounds like you'll be accelerating that progress going forward.

And I was just curious if you have any examples to share, evidence of the productivity improvements and how this is working as you go through the various formats nationally.

I'd say the biggest improvement we've made in the last 12 months is, now that we know what our new prototypes look like -- because prior to this, Jeff when I explained it, it was sort of a real estate strategy drove the decision from the 40 million square feet, that famous 40 million square feet we talked about two years ago, and how we are going to rationalize it in terms of what is the right number of stores per market to cover the target consumer, and what are the prototypical square footages we want in each one of our brands?

What we weren't talking about as much a few years ago is now we introduced these new prototypes.

So I'd say the change for this year is that, as a real estate team -- and you're right to say -- I've actually been impressed.

They've gained quite a bit of traction.

Now, the wind has been at our back given who we are, our size, our multiple brands and the fact that there's clearly an excess of square footage out there when it comes to landlords and different types of store fronts that we can consider for our brands.

And there's less and less new entries and new retailers and competitors who are announcing massive investments in their store model and their capital programs.

We are well-positioned, and I've seen great evidence, particularly at Old Navy, where we've gone out, we've either relocated across the street or been able to negotiate a reduction in space, get great terms from landlords in terms of the capital costs and great terms in terms of putting our new model into that store.

I think part of that has been that we are one of the few people, we're not the only company, we're one of the few people right now who are willing to put capital, because we have a plan, we have a strategy, we've tested these new prototypes and we know we get the return we need.

And we are now stepping up, as you saw with the Old Navy business, stepping up the amount of remodels we're doing.

Given that, that makes us pretty unique in the marketplace.

We've been able to use that not only to the betterment of the store and for customers and for growing our market share but using that as a leverage point with landlords.

So I think that's the new piece that has probably led the real estate team to start achieving a greater level of success in 2010 than they had in 2009.

So would you say that you see this accelerating in the next two or three years versus the last two in terms of net reductions of the footprint?

Jeff, that's a mixed bag.

I would say, do the following.

Definitely I would say, and there's an acceleration this year I'm seeing in terms of us achieving and making further inroads into our real estate strategy.

Now, that doesn't only mean reductions.

Some of our real estate strategy decisions are not only based on that or based on consolidations.

But I am looking at an saying in 2010 and 2011 we are really well-positioned, but I'd say better than I would have told you two years ago, to actually execute on it.

And I'm hoping, to your point, we've got to speed it up by at least a year.

But time will tell.

If I just keep giving you an update on it, what I'm hoping with the inroads I've seen made so far this year that that will bode well for an acceleration of it.

It's a little too soon to tell.

(Operator instructions) Edward Yruma, KeyBanc Capital Markets.

Congratulations on the strong quarter.

You were very aggressive with share repurchases in the quarter.

I don't know that they outclipped free cash just by a touch in the quarter.

How should we think about targeted cash levels and your interest in doing share repurchases going forward?

There's no change at all in our commitment and our principal around cash distribution.

So, as you know, we target about $1.5 billion in cash we want to keep on the balance sheet.

We were successful in generating a lot of free cash flow during 2009, and we intend through our new authorization of $1 billion that we announced earlier this year, to continue our repurchase program.

So we are pleased that we did almost $300 million in Q1, and we have every intention of continuing throughout the year.

Michelle Clark, Morgan Stanley.

Sabrina, can you quantify for us the in-transit impact to inventory at the end of Q1?

Glenn, you had mentioned in your prepared remarks the Old Navy assortment getting a little bit too broad and then needing to tighten that up.

Can you just give us some more color there in terms of what specifically you mean and then the opportunity to go forward?

I think it's fair to say that the in-transit really is the primary overage from where we had thought we would be.

So it's definitely worth a couple points of that inventory per square foot number.

Again, it's driven by Old Navy in transit, then wanting to get more fresh goods into the stores sooner.

That's where the overage came in.

On Old Navy, what I would say is that Tom and team have been pursuing for the better part of the last year adding some new businesses into the four walls of Old Navy so you have what's known as our [GOGA] business, women's active, followed by our men's active business, known as [RecTech].

We've been putting in a lot more non-apparel, led by jewelry.

Simultaneously -- and there's a number of other -- there's the licensing business we've put in, in kids and baby.

There's a lot of new businesses and categories as Tom has been executing on his category management plans and strategies.

Simultaneously to that, because after all it is only one store and one set of square footage, Tom was planning to reduce some of the C.C.

count in some other categories, and we are looking at it and going, but those are good categories for us.

We're going to be in them -- it's more of a complementary category than a dominant category.

And those two plans did not line up at the same time, which is unfortunate.

Tom is aware of it.

So it was a bit of a six-month overlap that Tom is now dealing with because if you went into our stores in February, March and April I think the people who were close to our business it probably would have been evident.

But I suspect that Nancy and Tom, based on the work they've done, will have that completely corrected by July.

It's not a big problem.

It's just that it's tough for some of the key categories that you are putting in, new ones or ones we've agreed are part of the future and we do want to dominate on, it's tough for them to shine and tough for them to actually get the space they need to gain market share against our identified competition if these other categories that should be reduced in space a little bit and be given a little less prominent position, the C.C.

count doesn't come down in those correspondingly.

So I would say -- a big deal?

No.

A disappointment?

Yes, but one that is easy to rectify.

And come July, I think will be in exactly the place we want to be.

Barbara Wyckoff, Jesup & Lamont Securities.

I've been paying a lot of attention to the pants and jeans categories in Gap.

Are you doing anything to jump-start the tops business?

And by building bottoms inventory and intensification, will you throw off your historical balance of tops and bottoms?

It's almost like you were in a meeting with us yesterday.

I completely agree.

I think the team really understands that.

I would say what happened was when we relaunched denim in August, there was a lot of effort from Patrick and Martha and the team to really get that off the ground.

There was a big focus on it.

I may have mentioned this in a previous call -- I don't remember.

But if I didn't, what I probably should have said was with that with that focus there was a disproportionate amount of share of mind that went to it.

And I get that.

This format of marketing dollars that went towards launching that, which, again, I support and understand.

But the complementary work on the tops and therefore the split of business, the proportionality of sales between tops and bottoms is something that's critical for the overall store to be successful.

And that probably got a little lower than Mark is comfortable with in terms of the sales at the end of the day.

I think there's a little bit of work being done right now in our stores.

If you go see the new floral products that we have, everything else, I think that that was the beginning of them attempting to correct that split inside the business.

But, most importantly, to Michelle's question earlier, as we have become more nimble and become faster, the main thing now is that Gap under Pam Wallack's leadership has been able to move very quickly on a speed process in a separate pipeline to bring in some tops much faster.

I just heard the other day at this meeting that we were just at that, come August, when the denim anniversary happens and our marketing campaign hits on July 27, talk about denim from last year's anniversary and taking it to the next level, we will see, this time, a much better presentation of mix of tops and bottoms inside the store.

Marni Shapiro, The Retail Tracker.

Congratulations on a great first quarter and good luck with summer.

You've been doing some very interesting things marketing wise to your cardholders recently.

I got a mailer every Wednesday, Gap loves Wednesday, and I know you are running a 10% off if you use your card.

So I'm curious if you have increased the use, to -- promotions to the cardholders.

If you have changed these up, are they working?

And is it specifically targeted -- most of them seem to work in-store only.

Is that purposefully, or are you running separate ones for online?

I would say that there are times there's a cross-mall channel deal with our private label credit card.

That does happen.

But you are right.

Your observation is correct.

I'd say, for the most part, they are independent decisions and a lot of them focused inside the store.

I'm sure you know this, that we have all the data that shows that a private label credit card purchaser not only in terms of their frequency but their average trends trumps a non-cardholder by a significant amount.

And us along with our credit card partner, using their information and their muscle and their experience and, in some cases, their marketing dollars, supported by the work we do internally -- we've been probably shifting that a little bit in all brands, to speak to that cardholder specifically.

What we do find is this -- without -- as they say in politics, we want to have a big tent.

We want to invite everybody inside to our stores and try to get new customers.

But there's two sides to marketing.

There's the customer acquisition, and then there's the strength in your strength.

And I think we probably have shifted a little more money towards holding onto the customers we have and trying to get a larger share of wallet from them as opposed to going after new customers -- not a big shift, given the numbers, probably a 10% shift in our marketing efforts have gone towards that.

It's probably why you seen a step up to you, if you are cardholder and you have a Gap, Old Navy, Banana card, we are speaking to you with a little more frequency and getting you to come in, probably give you a little bit of a heads up in advance of going to markdowns, probably giving you a bit of an advanced notice when a new product comes in that you should come in first and giving you this case 10% a little added incentive to drop by our stores.

So I think it's the right strategy for now.

There may be a time that we choose to switch back to an equilibrium or to put more money into customer acquisition.

But right now we've been trying to get a bigger share of wallet of existing customers.

I, for one, think they are a great and they're a nice surprise when you receive them, so congratulations and good luck.

Evren Kopelman, Wells Fargo Securities.

I had a question on the rod, given it's going to be a significant component of the margin improvement going forward.

Can you talk about where -- maybe don't want to talk about where it is as a percent of sales.

But compared to history, where it was this low level when it was a percent of sales, where are we?

How many -- is it several hundred basis points?

I'm trying to figure out what is the opportunity, where can that go?

One data point is this comparison to 2005, where we have deleveraged since then by about 250 basis points.

So we have a really, really nice runway in terms of rent and occupancy.

And as you know, not only does that come from increasing our sales per square foot, getting our productivity back, increasing top line.

But also all of this work that the real estate team has been doing during the recession, to really capture the opportunities, lock in some favorable rent, do some good deals.

We really feel like we are positioning ourselves well in shrinking the square footage, getting rid of unproductive rent, locking in new favorable long-term rent -- that, combined with an increase in sales, really gives us this nice opportunity with -- we definitely would like to head back toward those levels of leverage that we enjoyed just four years ago.

Paul Lejuez, Credit Suisse.

A question on the remodels at Old Navy.

Glenn, what is your goal there?

What kind of lift are you looking to get out of these remodels?

Sabrina, can you maybe share with us what sort of accelerated depression might have been included in that Rod line this past quarter?

Here's what I can tell you, Paul, that traditionally remodels for many retailers, I think that some of them are just barely successful.

In some cases people do it for brand enhancement.

And they don't necessarily do it because it's accretive to return on invested capital.

As you know, last year we did five, and they went quite well.

Then we decided to really move forward and get to 50 very quickly.

And those 50, for us to make then turn around and do close to 200 in the first half of 2010 should probably indicate to you that, from my experience and definitely from Gap Inc.'s history, that we had a bit of a tiger by the tail.

And in fairness to the remodel, part of it is we hadn't done anything to the stores in 15 years.

So when you do go in and you make quite a significant change -- you've seen those stores -- it's quite a significant look and feel.

The merchandise looks a lot different.

Like I said in a call, maybe a number of calls ago, that we are probably two or three generations behind on Old Navy.

So when you make this big shift from no effect to the look and feel and environment, for 15 years, and then do it, customers have really responded well.

And that tends to be a customer that I think actually really likes that and feels special about it and really makes that store.

You go into some of our defined competitors in the value business and come into our stores, it's a completely different feel.

It's one of our advantages.

It's the personality of the brand, which I think we lost.

I was in two years ago at a bunch of Costco stores, and they looked way better than the Old Navy store.

That's a game we can't win from an environment perspective.

Now I think we've regained our advantage.

So I think we feel actually pretty good about what Tom and the team have done.

They've been smart, they've been strategic.

The execution and the opening by the field leadership team at Old Navy have done a phenomenal job.

I'm out this weekend in stores with that team.

I know there's another 50 or 60 that are coming to the grand openings this weekend.

So a really good program, so far, that we are invigorated about that.

With regard to the amounts, we haven't specifically quantified them.

But they definitely were occurring in Q1.

You actually get a ramp up in Q2.

Even though we did about 100 in Q1, as Glenn mentioned, most of those stores were opened at the very end of the quarter.

So you do get some of the new depreciation of all the new fixturing and everything coming into Q2 that's going to impact Q2 rod.

So both on the SG&A -- and also the SG&A preopening costs -- not preopening but marketing costs for the grand reopenings -- are going to fall into Q2 more than Q1 for the bulk of those stores.

That's why, even though numerically we got 100 done in Q1, 80 more remodels to do in Q2, more of the expense falls both on the rod line and the SG&A line into Q2.

And then, of course, it's a one-time falloff in the second half.

John Morris, Bank of Montreal.

My congratulations I want to add as well.

Unless I missed it, I wanted to just get caught up with Sabrina on the SG&A.

You guys were pretty well controlled in the quarter on the SG&A line, and I'm thinking from a full-year basis the year -- full-year guidance numbers assume the same kind of order of magnitude of SG&A, up about mid-single digits?

And within that, your marketing plan, the spend there -- has that been the same for the full year, particularly as it relates to advertising spend?

Overall, our plan on SG&A is we are going to remain very disciplined in our base businesses, and we intend to leverage when we are successful at increasing our sales.

Nominal dollars, of course, are going to go up because, as you know, about half of all of our SG&A is store related.

And a big chunk of that is variable to sales.

But just as you saw in Q1, even though dollars when up $41 million, we leverage.

And what we are flagging is the timing of these investments in growth may change quarter to quarter, the profile.

But overall, we're looking to leverage SG&A on our base businesses and, overall, do very well and tightly for the full year, even with our growth initiatives is the goal.

With regard to marketing, we haven't been specific about the back half.

Our plans are actually still being laid out, certainly for the fourth quarter and somewhat for the third quarter.

For the second quarter I'd say directionally it's probably going to feel like the first quarter.

So we're going to continue to invest incrementally in Old Navy, driven primarily by the grand reopening of the remodels, where we do radio and we do some specific spend behind them.

And then also more investment behind athletic catalogs to get them out to more new customers.

And then Piperlime -- you may have noticed were doing a lot more print in Piperlime to bring new customers onto the website.

Glenn, are you happy with the marketing direction?

Any change in philosophy, or has it been pretty consistent all the way through?

I think it all comes down to keeping it fresh and obviously very happy with the creative platform that Tom and his team put forward last March.

But having said that, we have a brand-new CMO joining us in a few weeks, and she's highly talented with a lot of experience.

I believe Amy is going to come in and probably not change anything with the platform but maybe take it to the next level.

There's been a little bit of innovative ideas coming out from our ad agency and the team that's currently there, which is also highly talented, the team that currently does the work.

So I'm looking forward to Amy coming in and taking it to the next level.

I'd say at Gap, that they are and they will be taking the formula they put forward for 1969, which was not only the fact that it was a much more modern approach to marketing, I think.

But it had, definitely, more of a sexy feel to it than what they did to it in the 1969 launch.

They are using the medium they used, the way they really totally leveraged our store and our store team.

You're going to see them do that much more going forward.

We probably arguably should have brought that formula to the spring's marketing.

We didn't, but when you compare them, the holiday work we did versus the 1969 work we did, the 1969 work, which was product specific in key categories, much more relevant to the consumers and, maybe I would argue, to the lower end of our 25 to 35-year-old range.

I think that's a formula we are going to see going forward.

You will definitely see a version of that for the anniversary of 1969 on July 27, and you'll definitely see -- and I saw it last week -- a really cool way of doing it for black pants, which will be marketed at the end of August of this year.

Banana Republic -- I think Jack and Catherine and the team have done a great job on the marketing there.

My overall feeling with them is that they are putting more money in store, which matters for that business.

But in general, you heard my opening comments.

I'm still looking for a step up.

We have a strategic advantage in the amount of marketing we spend per year, and I want to make sure that we make every dollar counts.

Lorraine Hutchinson, Banc of America/America Merrill Lynch.

Glenn, have you had the opportunity to test some of the new black pant offerings and other low risk categories that you are talking about really stepping up the investment in?

And then also, are you considering television for the relaunch of 1969 and the black pants initiative?

There will definitely be no television.

I was just saying to John earlier that the formula on how we did on, say, a big investment in the stores and the windows inside the stores and giving actual funds to our stores to go out and get people to come in and get the trial going, adding more labor, creating experts like we did in 1969 -- our field team did an excellent job with that -- you're going to see -- plus then the external marketing to draw attention, social media, the fashion magazines.

This formula we've worked out -- it's going to be tweaked, obviously, because black pant is a different purchase.

But I think the team has taken that overall framework and applied it to black pants.

Therefore, there will be no television.

The testing -- sometimes there's things we're testing -- and I agree with that, sometimes you've just got to say what we believe in this.

And the test for me that was important, is Patrick and Mark and Pam had a number of very important fashion editors to New York about two to three weeks ago.

And my feedback that I got independently from a few other people was the same sort of feedback we received a year earlier, when we did the 1969 denim, we brought them in and showed it to them and they tried it on, was equal to the feedback we got in the black pant relaunch.

So that made me feel very good, and I'm a big believer -- it's a big business and sometimes you've got to test concepts.

And sometimes you've just got to say, you know what, that's strategically correct, we've done it before, we're going to do it again.

Let's just put it out there and make it happen.

Thanks, everyone, for joining us on the call today.

As a reminder, our earnings press release, which is available in GapInc.com, contains a recap of the Q1 results and the forward-looking guidance included in Sabrina's remarks.

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

Thank you.

Thank you for joining today's conference call.

You may now disconnect.