蓋璞 (GPS) 2010 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen.

My name is Chanelle and I will be your conference Operator today.

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

2010 conference call.

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

(Operator Instructions)

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

Good afternoon, everyone.

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

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

I would like to remind you that the information made available on this webcast and conference call contains forward-looking statements.

For information on factors that could cause our actual results to differ materially from the forward-looking statements, as well as reconciliations of measures we are required to reconcile to GAAP financial measures, please refer to today's press release as well as our most recent annual report on Form 10-K, and our most recent quarterly report on Form 10-Q, all of which are available on gapinc.com.

These forward-looking statements are based on information as of November 18, 2010, and we assume no obligation to publicly update or revise our forward-looking statements.

On the call today we have Chairman and CEO, Glenn Murphy, and Executive Vice President and CFO Sabrina Simmons.

Now I will turn the call over to Glenn.

Thank you, Mark.

Good afternoon, everyone.

Before I hand the call over to Sabrina to take you through the financial results for Q3, I thought I would spend a little bit of time giving you some updates from a meeting we had a month ago in in New York, in which myself and Sabrina and other senior executives from the Company laid out our strategic plan for Gap, Inc.

going forward.

In that meeting, one of the key topics that I touched on was that our goal is to have our sales comp on a quarterly basis between 0% and 5%.

In this quarter we had a flat comp in Q3.

On the low end of the range, but within the range we feel appropriate for the long-term view and where we want to take our business.

By the way, that makes five quarters in a row that the Corporation has been within that range.

Let me touch on the growth initiatives we spoke about a month ago.

So in the last week we've opened up our stores in China, which is very exciting for the business.

We now have Gap brand operating in both Shanghai and Beijing, three stores open and our fourth store is going to open up in a couple of weeks.

What I'm actually most excited about when it comes to China is our online channel opened up simultaneously with our stores.

That is part of the Company's long-term view and strategic approach to winning in all of our markets, is open up our brands and then complementing that with our online and our outlet business.

I'm actually heading out on Friday to spend a few days in China visiting with a team and getting an update on our progress so far but it's a milestone moment for the Corporation.

Very quickly following on the heels of the China opening, we opened up Gap brand in Italy, our first store in Milan.

After that we'll be opening up Banana Republic, also in Milan.

So that's another great initiative for the Corporation.

Our international franchise business just continues to get stronger and stronger.

We opened up Sydney in Australia, which is our second store in Australia, followed on the heels of our most successful store opening ever for the franchise business, which was in Melbourne.

We also opened up a new country in Croatia.

And our total sales in the franchise business for Q3 were up 45%.

And our store count year to date is up 20%, which really puts us on track for the target we've set for ourselves, which is doubling our store count in the franchise business to 400 stores within the next five years.

Banana republic in Europe opened up its fourth store.

We now have four stores in London.

This is the beginning of exposing Banana Republic, first with London, then followed by Milan, followed next year by Paris, and taking that brand out into the European market where Gap brand is already very strong.

Our Banana Republic factory stores, we now have four of those stores in Japan.

We've had Gap outlet stores in Japan for many years but this is the beginning of introducing Banana Republic factory stores into the Japanese market.

On the online business, let me touch on one of our sub brands which is Piperlime.

We introduced apparel just over a year ago.

Now we are working with vendors to bring in some private label apparel, and it's off to a very nice start.

We know this is the path we've defined for Piperlime, so it's one step at a time from its infancy four years ago as an online shoe retailer only, to now being able to provide multiple categories at multiple price points for the all the Piperlime customers.

Now, here at home in North America, I would like to just touch on two key initiatives that each one of the brands is working on.

I don't feel that it's necessary to get into too much detail because just a month ago we were together in New York, and each one of the brand presidents, Marka, Jack and Tom, spoke extensively about their strategies on product and other key initiatives.

So I just want to update you on marketing effectiveness and how I'm feeling about consistent product execution.

One area that I'm beginning to see some improvement is our marketing effectiveness.

And I'm seeing that to different levels across all three brands, but certainly as I look at November and into December I'm seeing an improvement in the mix of the marketing.

Whether it's social media or whether it's magazines to in-stores to windows, I think the mix is definitely better than it was last year.

And I think the creative is more reflective of the customer that the business is targeting, the customer we want.

And that's very evident in Gap's campaign.

Much more modern, and it's really where Gap is positioning its business going forward.

I'm seeing that in their stores, in their windows, in the magazine creative that came out last week.

I think Old Navy has had very good creative but when I think through what is actually on the air today and what they have planned for Thanksgiving and for Black Friday -- I'm only speaking about the creative now -- it's much more attention grabbing, it's much more disruptive, which is what Old Navy needs.

The value proposition is still very strong.

But I think the quality of the creative is certainly a step up than what it was last year.

And everybody, I think, has seen the Banana Republic creative.

I know it's been talked about a lot but it really looks great inside of their stores.

So they complement it with their new styling.

Again, their windows are much more noticeable when I walked the mall last week.

So I think that marketing effectiveness for us is moving in the right direction.

Here in North America what everybody is spending a lot of time focused on is getting to consistent product execution.

Now, that starts for us as we look into the fourth quarter with a better balance of inventory between fashion and basics, between tops and bottoms.

I don't think the product is exactly where we want it to be when it comes to that balance.

But for the first time in nine months we are in a much better position than we have been in, in terms of striking that balance, particularly when it comes to fashion verses basics.

One of the areas that's helped us get there in this fourth quarter is our new speed pipeline.

It's in the early days, it's a small part of our assortment coming off of that pipeline, but being able to react between eight and 16 weeks is making a world of difference for us.

Again, it's in the early days but I am noticing that when I go to stores now and speak to our managers about what is selling and more often than not what they are feeling good about.

This product was designed and developed on our speed pipeline.

Looking forward into Q4, speaking to all our brand presidents, speaking to our field leaders, discussions Sabrina and I have had, we are not expecting the fourth quarter from a consumer sentiment perspective or from the level of promotional activity to be any better than it was in Q3.

So that is our mind set coming into this very important fourth quarter.

Lastly, there has been a lot written, and a lot of questions being asked, about the sharp rise in the commodity price of cotton.

So, from our business perspective, I think we continue to work all the angles that are available to us, all the tactics that we have been utilizing for the last couple of years.

My job is to make sure it doesn't become too big of a distraction to the business.

It's a reality that we have to deal with.

We have a lot of advantages here at Gap, Inc., whether it's our size, the number of countries that we currently source, in order for us to achieve the goal of minimizing that rise in that commodity to our overall cost of goods.

But it's a reality everybody is dealing with in 2011.

In closing, let me say that at a strategic level Gap, Inc.

is striking the right balance between managing its business, its core business, here in North America, while making the necessary investments for success in the long-term on a global platform in a global arena.

The key for the Company going forward is to execute at a very high level.

We want to grow operating margin inside our business while making these investments and then returning cash to shareholders, like we did in Q3.

So from my perspective we have the right strategy, we've put the right talent into place, and now it's up to us to deliver every single quarter.

With that said, let me pass it on to Sabrina who is going to take you through the financial results from Q3.

Sabrina?

Thank you, Glenn.

Good afternoon, everyone.

I'll start today by reviewing third quarter performance and then talk about what we expect for the rest of the year.

For webcast participants please turn to slide four.

We are pleased that we continue to deliver on our goal of growing top line sales.

Third quarter net sales were up 2%, to $3.65 billion versus $3.59 billion last year.

Total Company comp store sales were flat in the quarter versus flat last year.

Online sales grew 15% and franchise sales grew 45%.

Turning to earnings on slide five, third quarter operating income was up $4 million, to $504 million, and operating margin was 13.8%.

The effective tax rate was 39.6%, up one point versus last year driven by launch costs associated with our international businesses.

Therefore our third quarter net income was down slightly in the last year at $303 million.

Our earnings per share, however, was up 9%, to $0.48 supported by our share repurchases this quarter.

Turning now to gross margin on slide six.

The third quarter was very promotional, resulting in gross margin rate decline of 130 basis points.

However, the gross margin of 41.2% is the second highest third quarter gross margin rate in the past decade.

Merchandise margins were down 180 basis points, driven by increased promotional activity at all brands, and this was partially offset by rent and occupancy leverage of 50 basis points.

Gross profit for the quarter decreased 1% to $1.51 billion.

Moving to inventory on slide seven.

As a quick reminder, this year we made investments in key product categories for fall that took our inventory levels higher than we consider optimal.

Total Gap, Inc.

inventory dollars at the end of Q3 were up 8% to $2.2 billion.

Inventory dollars per square foot were up 9% for Gap, Inc.

It's important to note that some of our inventory increase is related to our international launches.

The growth in inventory per square foot for North America was a couple of points below that of Gap, Inc.'s.

Turning to slide eight, operating expenses.

In the face of merchandise margin pressure during the quarter, we responded with disciplined expense management, leveraging operating expenses by 110 basis points.

Total expenses declined by $23 million to $1 billion.

Included in total operating expenses are investments in our growth initiatives and $142 million of marketing.

Please turn to slide nine.

Year to date we've spent $413 million in capital.

The spend has been focused on three areas -- Old Navy remodels, launching online globally, and opening international stores, particularly outlets.

We've opened 44 stores weighted towards international outlets, closed 57 weighted toward Gap brand, and ended the quarter with 3,082 Company owned stores.

Total Gap, Inc.

net square footage was down 2.5% compared to Q3 2009.

Regarding cash flow on slide 10, year to date, free cash flow was an inflow of $523 million.

We continue to demonstrate our commitment to distributing cash, as evidenced by our year to date repurchases of 67 million shares for $1.4 billion.

We ended the third quarter with about $1.7 billion in cash and short-term investments.

Now please turn to slide 12 for our outlook for the rest of the year.

As we focus on our goal of driving sales growth, we anticipate that the upcoming holiday season will be highly competitive and that spending patterns will remain choppy.

We are reaffirming our full year earnings per share guidance of $1.77 to $1.82 per share, which we believe encompasses a reasonable set of outcomes for the holiday season.

As a reminder, our EPS guidance represents a 12% to 15% growth versus last year.

Here is some additional information for the rest of the year.

In addition to offering compelling values in store and online, we're investing in marketing to drive traffic.

That said, we do expect marketing dollars to be down about $15 million versus Q4 last year, primarily due to our decision not to use TV for Gap brand this holiday.

Moving on to inventory, we expect total inventory per square foot for Gap, Inc.

at the end of the fourth quarter to be up in the high single digits versus last year.

However, similar to Q3, we expect the inventory per square foot increase in North America to be lower than that of Gap, Inc.

in total.

We're also updating our guidance for store count and square footage.

We still expect new store openings to be about 65 for the year but we now expect about 100 store closures versus earlier guidance of 110.

The reduction is primarily due to favorable lease extensions in some of our Gap stores.

We now expect full year square footage decline to be 2% versus the earlier guidance of about 3%.

Regarding cash, as is our normal practice we periodically review the target levels we have and have decided to bring our cash target back down to $1.2 billion.

Cash above this balance sheet targeted level is considered excess and available for distribution to shareholders.

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.

In closing, we are pleased that once again the management team deployed both P&L and balance sheet levers to drive earnings per share growth this quarter.

As we look forward we will remain focused on delivering consistent performance in our North America businesses and expanding internationally through all of our channels.

While we pursue these strategies, we continue to generate and distribute significant amounts of cash which we believe is an important component in meeting our overall objective of driving value.

Thank you and now I will turn it over to Mark.

Thank you, Sabrina.

Operator, that concludes our prepared remarks.

We will now open the call up to questions.

And, everyone, we'd appreciate if you could limit your questions to one each.

(Operator Instructions) Your first question is from Betty Chen with Wedbush Securities Incorporated.

Thank you, good afternoon.

I was wondering, Sabrina, if you can talk to us a little bit about the philosophy around cash.

I was curious what was the decision making process that allows you to bring the target cash balance down to $1.2 billion?

Thank you.

Sure.

We review our cash target at least annually.

And you might remember that our cash target had been $1.2 billion before we hit the financial crisis in 2008, where we, like many other companies, took a more conservative perspective and raised it.

So what we do when we look at the analysis annually, Betty, is we look at all kinds of variance analysis, whether it's value at risk, whether it's looking at worse case scenarios.

We want to make sure we can self fund ourselves through a downturn and not be reliant on capital markets, is basically the philosophy to derive the balance sheet cash.

So we want enough for our working capital and then we want to reserve for a downturn.

And we are comfortable having moved through the financial crisis in 2008, the deep recession in 2009, with very intact free cash flow generation, that we are in a position where it's not difficult for us to lower this cash target.

Thank you, that's very helpful.

Your next question is from the line of Jeff Klinefelter with Piper Jaffray.

Yes, thank you.

Glenn, I was wondering if you could just address the square footage growth or net reduction question.

I understand that the numbers Sabrina shared with us here for openings and closings at year end.

But just curious about your perspective on overall net reductions going forward.

You've talked about this for a couple of years and opportunities to shrink your footprint, become more productive.

Other retailers are starting to talk about it a little bit more directly or aggressively.

What do you see over the next couple of years in terms of opportunities to shrink that base?

I guess I'm glad we started a trend.

We still actually feel pretty good about it.

I think we have been pretty consistent for the last 12 or 18 months in saying that from Gap's perspective the real opportunity is the consolidation.

I was just in a real estate meeting yesterday, and once again seeing numerous opportunities to go into what we consider to be A-type malls where we have an independent kids and baby store, an independent adult store.

When you combine the square footage, it's just way more space than we need and we just moved the kids and baby into the adult business.

We've learned a lot of lessons over the last couple years from our Japanese team, our European team about how to densify stores, while still offering a very good experience.

And I think a lot of the new store model prototypes we've worked on the last couple of years, they have been first about what is the right thing for the customer, and then how do we make it efficient for our employees, and at the same time how do we get an increased level of assortment that philosophically we didn't believe in a number of years ago.

That's still intact.

We are feeling good and we still get a lot of opportunities to make that happen with Gap brand.

Old Navy has been, more than any other brand, I would say, on a bit of a roll in the last six months.

And you will see most of those, Jeff, work their way into our numbers in 2011 where those are just straight reduction of space.

Old Navy started building more and more stores in that 22,000 to 28,000 square foot range.

Our prototypical size for them is happiness begins at 15,000.

We will do some 17,500, and very rarely but in New York City, in ultimate flagship locations, we'll do stores in 25,000 square foot range.

So still feel very good about those, for the criteria we are looking at for those two businesses and the environment is still buoyant for us.

I think there is times when people come back into the market, it makes it easier for us to carve out space, it makes it easier for the landlord to make decisions with us jointly.

They now know what our plans are for 2011 and we've been sharing with them very recently what our plans are for 2012.

Our ultimate target of a 10% to 15% reduction in our domestic square footage, I still feel very confident we can achieve.

Your next question is from the line of John Morris with Bank of Montreal.

Mr.

Morris, your line is open.

Operator, we can't hear John, so maybe we should move on and come back to John at a later time and remind everybody to check their phone's mute buttons.

Your next question is from the line of Edward Yruma with KeyBanc Capital Markets.

Thanks very much for taking my question.

I know you've spoken a little bit about the reduction in advertising expense in the fourth quarter because you are not doing television advertising, but what other expenses do you have that you can cut due to this heavy promotional environment?

Thank you.

I think the television reduction is really at Gap.

That's the brand that we came back to television after a couple years hiatus in 2009.

I thought it was a decent campaign, it was not negative in terms of its return for us but didn't feel it was appropriate.

Preferred the new mix of media we are choosing now in order to represent the messaging -- some product messaging, the styling messaging, and when necessary the value proposition for people from, particularly starting next weekend when the value proposition intensity and our ability to compete actually steps up quite a bit.

Overall, we've been for three years, I think we've told everybody on the phone, there is no rock that has not been unturned in our business when it comes to SG&A.

Marketing is a significant investment for the Company.

We are doing two things.

One I touched on in my opening comments, is we are really challenging ourselves and our marketing team to look at the money we are putting forward because it is a strength of the Company, it is something we can differentiate ourselves on, but is it actually effectively returning what we want from it.

So that's one challenge that may lead to relooking at marketing going forward.

Not in a significant way but being intelligent about it because it is a big pool of money we invest.

Secondly, I think that you are seeing us shift a little bit of our marketing money into our store.

I think a lot more attention being put into, whether it's windows, whether it's in store signage, whether it's marketing messages in the four walls, which is much more cost effective for us, but at the end of the day the customers seem to respond better than some of the marketing we have been utilizing historically externally.

This all comes down to finding the right balance.

I don't know anybody, whether you are a consumer packaged goods company or a retailer, who isn't constantly revisiting what that balance of marketing and advertising looks like.

We are definitely more tough minded than we used to be on what is the money, can we get the right cost that we think we deserve, we should get given our size and the amount we invest.

The latest twist is more probably even more focused on effectiveness and a bigger focus on the balance.

The only thing I would add, Ed, is that we just continue to look at every line item, and there is many within our expense structure, to make sure we are managing in a disciplined manner.

I think Q3 is again evidence that in the face of disappointment on the merchandise margin line, that we look at all of our P&L levers to make sure we ultimately are delivering value to our shareholders.

I have to say in the third quarter, it was -- our field teams, our store teams, should especially be applauded for their discipline in managing all store related expenses, especially in North America, in just the most responsible way.

And even while they do that, our customer service scores are still very strong across those brands.

So real compliments go out to the field teams for all their hard work.

Your next question is from Kimberly Greenberger with Morgan Stanley and Company.

Great, thank you, good evening.

Sabrina, I was wondering if you could talk about the inventory.

I'm not sure I completely understand the 2 percentage point shift because of changed shipping terms.

Does that mean you will just take balance sheet ownership of those goods in the fourth quarter?

And in terms of just your strategy on inventory management, how should we think about where you expect the business to normalize?

Is this high single digit growth rate in inventory per square foot likely to be sustained?

Thanks.

Sure.

So on the first one, Kimberly, what we did, I think probably beginning in Q2, you might have read in the newspaper and heard from some other retailers that we were all facing this phenomena of some slower shipping which was causing longer in-transit times.

So we always deploy various payment terms for our vendors.

A lot of it is FOB, and then we also have DDU which is when we take delivery later.

So in the face of what began as longer in-transit times in Q2, we decided to respond to that and actually shift some of our terms with our vendors to take possession of the inventory later.

But we've always had both buckets and both terms.

We simply shifted a little bit in the face of the slow steaming and the longer in-transit.

We are likely to shift back to our normal percentages as we move forward in time.

So hopefully that answers the first part of your question.

The second part, I talked about how, when we had more momentum earlier in the year, we made the decision to invest in key categories for fall.

And now that we are through that fall period we very much want to bring our inventories more in line with sales growth.

Where that ultimately ends up, we'll give you color quarter by quarter, as we typically do, but what we wanted to point out in this call is that importantly the North America inventories are making progress.

What is happening to our total inventory per square foot is it's getting a bit skewed because of our international launches.

So what I mean by that specifically is, and I will use an example, for the stores that are opening in China now, we obviously had to buy inventory for those stores.

And they're big, brand-defining flagship stores, so it's not a small amount of inventory.

We buy that in advance and we actually don't have the square footage counted in our base when we report square footage for the third quarter because those stores haven't opened.

So you are going to have an elevated inventory build for those big flagship international launches.

The second factor that's happening with our international growth and focus is you are going to start to get more of an impact from foreign exchange.

So our inventory in the third quarter is higher by $16 million due to foreign exchange translation of taking our inventories in our international businesses and bringing them into US dollars, and that's worth about a point.

So that's why we're starting to try and be more helpful and break out for you the difference to show that indeed we are making progress in bringing inventories down more in line with sales growth in North America, and that there is going be a difference occurring in international as we build those stores out.

We do have John Morris back on line from Bank of Montreal.

Thanks, can you hear me now okay?

Yes.

Sorry about that earlier.

Maybe a little bit of color on the merchandising and the progress you guys are making in the tops category, in particular at core Gap, Gap domestic.

Depending upon how you want to answer it, if you want to talk about casual versus fashion.

And segueing into bottoms.

Is the bottoms category, particularly denim, continuing to perform the way you want it to?

We thought maybe the five pocket jean had come off just a touch so just wanted to get some color there on the balance between tops and the mix in tops versus bottoms.

I think that -- John, it's Glenn -- the Gap team, for the first time, when I was referring to earlier about the imbalance of inventory in my opening comments, it was a Gap, Inc.

comment but in the back of my mind I was thinking about Gap brand, in particular, which you called out and I've spoken about it at a couple conference calls, and Mark talked about it in New York.

This slate of flow that came in on November 11, for holiday flow, was the first time that any of us would look at it and say the balance is at least headed in the right direction.

We know the kind of split we want to get, whether it's industry numbers, what we are just putting forward in our own business from a category management perspective, what split of tops to bottoms we want in terms of sales, what do we want to give to our actual customers when it comes to that split.

And as I said, looking back in the last seven days, and I was with the team yesterday, we are starting to at least feeling better about not only on an inventory assortment perspective, but also, as you referred to, the tops that came in, were done, some were done in advance, in fairness to that team, but a lot were done on this pipeline I spoke about earlier that allowed them to, one, acknowledge the missed opportunity, deal with it to make room in their open to buy, and then bring in the right tops.

And you will see that as you walk around the store, I think.

From my perspective it's noticeable from what I've seen the last nine months.

So that's a positive play.

On the denim front, there is a bit of a shift going on in the last maybe two to three months in terms of our five pocket business which has been very strong.

We launched it last August.

If you look at the market share data, we've made a lot of gains.

If you look at the market data overall, five pocket is slowing down and fashion denim, where in our case we brought in the black pants, we are giving her a lot more options.

For holiday season we are making a huge investment in black denim, which doesn't show up, obviously, it's not considered fashion inside of our business.

So Rosella and her team in LA, we moved our whole denim operation to LA, you will start seeing the beginning of the work her team is going to put forward early part of next year.

And I think she really gets, understands, being in LA, in particular, understands where the trend is going, what our customers are looking for, what is that right balance between five pocket and fashion.

So I think this particular holiday season, last year we rode the five pocket wave all the way through holiday, here we've diminished that presence a little bit from a merchandising perspective inside the store and we've really played up the black denim to complements all the new fashion tops we've brought in.

So I think a better mix than last year, definitely more in line with what customers are looking for from Gap brand, but not ultimately where we want to end up.

Your next question is from Janet Kloppenburg with JJK Research.

Hi, everybody, can you hear me?

Yes.

Okay, great.

Glenn, just as a follow on to that question, I think from your supply chain, greater efficiency in the supply chain, you're able to react somewhat with both Gap and Old Navy for the holiday season.

So should we expect a further improvement in inventory content as we get into December?

Should we expect to see things get better there?

And for Sabrina, just in terms of inventories, it's still a little confusing to me what you are saying.

But if you are looking for a flat 5% comp, I think that's what Glenn said is what you would expect, in the domestic business, should then we be thinking that at the end of the fourth quarter and beyond that that's where inventories for the North American businesses will be?

The in-store businesses, obviously.

Janet, on the speed front first, which is we talked about last time we were together, I think I mentioned on my opening comments trying to get more and more of our product on a pipeline that's between eight and 16 weeks.

You might see a slight improvement in the December flow.

I know our December flow is a little larger than last year, it's coming in a little bit earlier.

But in terms of a percentage of the total assortment, I don't think you will really see a step up.

And this is what's in the store today is still very small as a percentage.

But coming into spring, the product that gets delivered in the first week in February, for Gap brand, Old Navy and for Banana Republic, that is now starting to become a much more meaningful part of their assortment.

They are not going to end there.

The goal, and we've had these meetings now for the last six months, is that every single season we will leave ourselves more open to buy, available for each one of the brands, they are working with the supply chain.

We worked it through all the processes and we've spent quite a bit of time on this, and my goal is that every single season we'd see an improvement in the amount and therefore the productivity of each one of those brands by using the speed pipeline in a much bigger way.

I think to answer, hopefully in a simple way, your question, Janet, I think it would be a good goal for us overall to work our inventories in North America towards that same zone that we are targeting for in comp.

I think it's really important to remember that our square footage in North America is declining.

So in the third quarter the North America square footage has declined by 3 percentage points.

We are trying to increase total sales for North America on smaller square footage.

So we will want to have a little bit more inventory per square foot in order to drive to that goal.

But I think in the spirit of your question, we'd want to drive towards that range.

I don't know that we will be exactly there at the end of Q4.

And again, we are reducing the square footage in North America and that's going to be a big component, an important component, to keep recalling as we think about where we want the inventory per square foot.

Your next question is from Brian Tunick with JPMorgan.

Thanks, good afternoon.

Glenn, circling around Old Navy again, just trying to understand maybe how you and Tom looked at the third quarter results and how that's impacting your either pricing, viewpoint on where Old Navy needs to be versus the competition, or some of the moderate department stores.

I know you also talked about the flow before, but just trying to understand how you are looking at maybe what you would have done differently at Old Navy in the third quarter.

And also, just for Sabrina, how many Old Navy remodels now are in the store base?

Brian, we talked in the, I think it might have been in a previous call where we were saying that Q2 performance on the sales front -- and to make sure I'm clear, I'm not exactly satisfied with Q3, but specifically above Q2 -- we were talking about coming into Q3 that we had to make some adjustments in the business.

We spent a lot of time with the brand presidents, we came off nice momentum from the end of '09 into Q1, and we were not able to carry that forward in Q2, when the consumer seemed to pause for a minute.

Some retailers were able to do it.

We were not able to do it.

So I think Tom, as much as any other brand President, took that direction very seriously and that's why, I think, if you look at his October comp, where he was able to get a positive comp in October off a double digit comp the previous year, I think he was able to start making the adjustments.

I'm not here to predict that's Tom's new normal and that's his trend.

What I can say is that the value proposition for Old Navy is, one part, we know who our competition is, we know what categories we want to gain market share in.

We know exactly what our customer expects of us in order to get her loyalty and get her in with more frequency.

And equally importantly, attract new customers into the fold.

But equally important with Tom's business in the raw value proposition, whether it's initial price, promotional depth of discount, markdowns, is how he communicates it.

I think that's where -- he has always been competitive.

I think he may have been -- Tom would admit being on the phone today -- may have been a little slow to respond in August and September to some of the activity from competitors.

I think he was more able to do that in October.

And I think now he has that same mind set coming into the fourth quarter, but going for him, more than in Q3, I think is a better voice for the brand.

I think the communication and the marketing which you will see this Sunday starting coming into the advance marketing of Old Navy for Black Friday, Thanksgiving messaging, and beyond, is now taking what has always been a very solid belief in what their value proposition is but messaging it and articulating.

Which, they've done a good job, but as I said in my opening comments, from a marketing effectiveness perspective, I'm seeing that Old Navy is really stepping it up, coming into the holiday season.

Hopefully that combination will allow Tom's business to resemble more of an October trend and less of a September trend.

Brian, there is about 250 stores that have been done in the new format.

Not all of those are comps because if we relocate or reposition or reduce the store by more than 15%, it falls out of comp.

But the majority are in comp.

Your next question is from the line of Evren Kopelman with Wells Fargo Securities.

Great, thank you, good afternoon.

Two questions.

One is on the speed pipeline.

Can you talk about the constraints to moving more product to that, more quickly?

And then secondly, your sales per foot goals in North America, you talked about moving them from $300 per foot to over $400.

How much of that is driven by the modest comp growth and how much of that is driven by the square footage reduction?

Thanks.

I think we may have mentioned before that the biggest constraint for us to embrace the notion of getting product designed and into our stores closer to when the actual customer sees it has been cultural.

And it took us a while to change how we have been doing business, more time than I would have liked to have seen, but we were able to finally get everybody rallied around.

The beautiful thing about this Company is once everybody embraces a new idea, then I find that people really step up and get it done.

We've seen that with the work we did in AUC the last three years, the work we did in SG&A, the work we did on real estate strategy, the work we are currently doing on marketing effectiveness.

When we rally around a new concept of something different from what we have been accustomed to, people tend to perform.

With that challenge now passed, we've got lots of vendor connections.

There are very good, well-respected retailers who have already been working with retailers on this notion of breaking down the decision-making time internally, working very quickly on turning product around between PO placement to getting product in the back door of the store.

And it didn't take a lot of time for our supply chain people to actually get that done and put into place.

And, again, I want to be clear, this is early days for us, but we continue to move this forward and analyze it, understand it.

But I'm putting quite a bit of pressure on all the brands, knowing that two retailers, in particular, that I respect a lot in our sector who are very good at this -- and we're not trying to become them, we just want to make sure we take this practice, apply it where it's right for us and then reap the benefit of getting product designed and bought and assorted and inventory decisions made on the PO closer to 16 weeks to the back door of the store as opposed to many more weeks that we have today on the core pipeline.

So early days, but as we said at the meeting in New York, we feel this is something that will help us manage our AUR coming into 2012.

And Evren, on your second question, this is how we think about it.

Our first goal is to get rid of unproductive square footage because that's going to help us not only on the sales front but also on the sales per square foot front.

But really importantly that's going to help us on the rent and occupancy piece.

So we look at where we can reduce square footage, number one.

Then our goal is to improve overall sales.

Now, with a mature fleet, that, by definition, has to come from delivering consistent, albeit modest, but consistent comps.

Then what falls out of that, of course, once you've reduced unproductive square footage, you drive to your goal of improved overall sales, is what falls out of that is improved sales per square foot.

And the opportunity I outlined at the October meeting was simply that, as recently as 2005, our sales per square foot were over $400, and in 2009 they were at about $330.

So that gives us a lot of runway to get back to a sales productivity that we have achieved in our recent future and get the added benefit of lowering our rent and occupancy while we do it.

Your next question is from Paul Lejuez with Nomura.

Thanks.

Can you maybe share with us the timing of when you expect to get to that $1.2 billion of cash on the balance sheet?

And then, second, just wondering, now that you've started shipping to 80 countries, where are you showing the greatest response, and are there any surprises in terms of which countries are strong for you guys?

Thanks.

Hi, Paul, I will take the first part of the question.

So, the good news is we've effectively released more cash available for distribution by lowering the target, right, because we view everything above that target as excess cash available for distribution.

When we'll get there we don't predict precisely because we approach share repurchases very opportunistically.

So that is difficult to predict precisely, but we report out every quarter.

And I think what you can count on us for is that we have shown very consistent discipline in terms of returning that cash to shareholders, especially this year having done already $1.4 billion in the 67 million shares, and $8.4 billion and 431 million shares overall since 2004.

On the expanding global online business, it's probably worth noting, first, that the most important change we made this past year was to set up our own business in Canada, our own distribution center, offering all three brands on our universality platform.

That allows us to do -- similar to what we just introduced here in the United States -- which is free shipping on orders over $50.

That was step one.

Then we went to Europe and did the same thing for our UK customers.

And now we just took that to nine different countries on top of the original launch in the UK, so that's 10 countries now where we ship -- for the other nine country in pounds -- but it is shipped out of a distribution center located in the UK.

In the new year, those nine other European countries will be shipped out of our UK distribution center but in their own currency.

That's really us controlling it.

And China, which we talked about in opening comments, the one thing I'm most excited about is it's the first country we've gone into where we've launched, opened a store, introduced a brand, and then simultaneously made ourselves available to people on a local distribution center with a site, that, of course, is in Mandarin and available for people in the market in China.

That is really part of the strategy of the Company which is brand complemented by channels, one channel being online, one channel being outlet.

The 80 you are referring to is shipped out of the US.

Shipping charges are fairly high.

The response has been growing every single week.

We're actually not too surprised about how well-received it's been in Korea, where we have a franchise business, how well it's been received in Australia, which we just opened a franchise business.

And I would say the way Toby's thinking about this is by getting a -- of the availability of online purchases in countries in which we don't have full control of our own distribution center and our own site, will give us a clear indication of where the highest demand is, and where should the next Canada, the next UK and the next China be.

We will be well informed by what we see, where the sales are coming from, on the 80 countries we've launched -- again, shipped out of the US -- with fairly, I'd say, less than attractive shipping fees.

The other thing I would say is a bit of a surprise but encouraging as we talked about in New York, as we give more thought to what could Old Navy international look like, by far the biggest response has been to Old Navy.

I think that speaks -- on countries where if somebody would show it to me, I'd say what would Old Navy's brand recognition likely be in that country, I would consider it to be low, particularly relative to the Gap.

But the percentage going to Old Navy in international markets through this new 80 country shipping service we have has been a pleasant surprise.

That's just a data point that helps us as we spend time considering what could the Old Navy international strategy look like.

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

Good afternoon, everyone.

As you talked about speed to market, and just a little bit more on that, as you think about each division and the gross margin opportunity for it, is there more opportunity for one division than another and further down the runway in one versus another?

Thank you.

I don't know, Dana.

I guess I haven't tried to handicap it by brand because we want all three of our brand leaders to know it's an equal opportunity for all of them.

So far it's going to depend on how they approach it.

When you think about it, particularly if it's getting closer to market, and those are probably more trend right decisions that are being made, you tend to probably assume it'll be a bigger opportunity for Banana Republic and for Gap in terms of making the right decisions, getting very quickly onto the right trend, whether it's by category, by color or any of those other choices that Patrick and Simon Kneen want to make.

I know they are very much supportive and love the fact that this pipeline has been created.

But the Old Navy, what has made it famous over the years -- and maybe not as strong so far this decade, but I know Tom and Nancy are bringing that back -- is fashion at a price has always been something that's at the core DNA of what Old Navy is all about.

So I really look at it and so I shouldn't forget about our outlet business under Art Peck's leadership, them following suit.

So all four, all three of our brands and Art's business, which obviously is a very successful part of the corporation, him and his team are also looking at how to make best use of this pipeline.

As I said, we got over the mind set shift about nine months ago.

We worked on the mechanics and now we're dipping more than a toe in the water.

From where I sit, my vantage point, this is only going in one direction because the early indications, obviously, we feel good about.

And it does simplify the business and allows the designers to do what they need to do, the merchant team to do what they need to do.

And the ultimate winner on this is going to be our customers.

Your next question is from the line of Lorraine Hutchinson with Banc of America.

Thank you, good afternoon.

Just wanted to follow up on the product cost issue.

You've been working on lowering your average unit costs for a number of years.

As costs mount for next year are there any offsets left?

And, secondly, how are you thinking about price points as an offset to some of the cost increases for next year?

The state of mind in the business, Lorraine, always has to be that there is always more we can do.

But you are right, three years ago, I think we characterized it back then that it's not that we were geniuses.

We really felt that we probably were leaving money on the table, whether that's through the processes we had, again the willingness to maybe not accept a new way of doing things.

And I think that maybe our partnership and our direction with our vendors could have been better in terms of our negotiation with them.

But yes, there is a lot more.

I read your report, I know that there is nothing that you listed that we either not have done already or not on our way of -- to getting done.

But one big change for us is, I think you referred to it as fabric platforming, our issue is we just have too many fabrics in the Company.

When I first - and the Presidents -- heard of the number of fabrics we were using versus some of the global competitors we admire, it was tenfold, in some cases.

So I think that getting to --which we worked on three years ago -- fewer vendors in terms of our relationships, getting real partnerships with them, and then working upstream with mills, which we've never done before, to get fewer fabrics that we believe in, and getting some longer term arrangements on those fabrics, which you can't get speed if you don't do that.

Because if you want to get the speed but you're not sitting on a new fabric with one vendor who's your partner, you can't develop anything, you can't get that amazing product in your stores.

I would say that's the one that we spent quite a bit of time in the last six months.

We have had a number of our design members and our merchandising team leaders around in Korea, in Hong Kong, in China, in India, meeting with vendors, on a number of different topics but this latest one, which leads to some cooperation down the road with vendors.

But I think it starts with committing the fabrics, committing to a term of period of time, where you have it.

It still allows you to do color and everything else you want to do.

But that, I think, is one area we are getting much better at and it should help us mitigate against some of the cost increases we're all going to face in 2011.

Operator, we have time for one last question.

Yes, sir, your final question will be from Dorothy Lakner with Caris & Company.

Thanks, and good afternoon, everyone.

Just wanted to follow up on that question for a second.

And just looking at, obviously, your size, Glenn, you talked about that in terms of being able to mitigate product costs.

But also just the mix of countries because it seems like you've got already a pretty big mix of countries relative to some smaller competitors.

So in addition to the work that you have done on fabric, are some of these other areas ways that you can help mitigate the costs going into next year?

As I said, there is always more we can do.

We got ahead of the curve about three or four months ago.

We didn't have a crystal ball more than, better than anybody else, it was just our view with how quickly it went up, even though there was some supply and demand reasons, it just looked like it was headed only one direction.

We started getting some very thoughtful and good thinkers in our business together and saying what are the other things we can do.

What else?

You can't take out your quality, you have to be true to your customer.

All those things were non starters as far as everybody in the room was concerned.

We have to deliver a product we can feel good about.

I'm a big believer that just because you can get cost out of your product, that doesn't necessarily mean you are taking quality out.

We are just pushing people to be more thoughtful.

Without, again, giving any Company secrets away, what I can tell you, the people three or four months ago who left that room with clear direction, that we are looking for a lot more ideas about how we had been doing things with some success the last three years.

The basic message they received from me at that time was it's not going to be enough.

We need more ideas, we need more fresh thinking.

And I'm impressed.

We have a lot of smart people in the Company.

Besides what we touched on before, and again was in Lorraine's report, you are dealing with a bit of a tidal wave here in terms of the absolute commodity price going up.

Our job is to make sure, again, how do we mitigate against that.

We have been looking at fabrications, we've been looking at options, we've been looking at counter sourcing.

And we've always, I think most companies like us have always had a bit of an adversarial relationship when it comes to vendors.

I think the best thing that's happened the last four months, when we saw the direction which cotton was going in, we built much closer partnership relationships with a lot of vendors and working in conjunction with them by having our people out.

We obviously have thousands of people who work around the world in these 50 countries we source from, and bringing us great ideas.

Like you said, we are not so dependent on China whereby we have the flexibility.

And all of our business is on wheels.

We can move it anywhere around the world where we think it's right, whether it's meeting new vendor relationships or strengthening the ones we have already.

So, look, it's --I'm actually pleased with what I've seen so far when it came to the work that was done on spring.

That's the only season we've actually locked down right now.

But as I look forward with some of the creative ideas, all I can ask from the team is to work really hard on mitigating the impact to the Corporation.

I then turn very quickly to everybody and say, "there is another side to the equation." The other side to the equation is the initial ticket down to the absolute AUR, which every good retailer knows is known as yield management.

There is still lots of opportunities.

We've never put a bright light on that part of the equation the way we have on AUC.

And now that light, with a different group of people in a different room, is being shined pretty bright and saying what can we do.

There's a lot more innovative ideas.

Speed is just one idea behind trying the get to a better average unit retail in the business.

So hopefully the combination of those two groups will put us in a better position than most, which is all I can ask of the team is, when it's all said and done, that we are better positioned than other companies through ingenuity, talent and tenacity.

Okay, thanks, everybody, for joining us today on the call.

As a reminder, our earnings press release is available on gapinc.com and it contains a full recap of our Q3 results as well as the forward guidance that was included in Sabrina's remarks.

And as always the IR team will be available after the call to take further questions.

Thank you.

Thank you, everyone, for joining today's conference.

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