蓋璞 (GPS) 2012 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen.

My name is Jamaria, and I will be your conference operator today.

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

second-quarter 2012 conference call.

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

(Operator Instructions)

As a reminder, please limit your questions to one per participant.

(Operator Instructions)

I would now like to introduce your host, Katrina O'Connell, Vice President of Investor Relations.

Good afternoon, everyone.

Welcome to Gap Inc.'s second-quarter 2012 earnings conference call.

For those of you participating in the webcast, please turn to Slides 2 and 3.

I'd 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're 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 August 16, 2012, and we assume no obligation to publicly update or revise our forward-looking statements.

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.

Thank you Katrina, and good afternoon everybody.

As has been customary in the last number of calls, I'm going to provide some color on the performance in the second quarter, and then I'm going to hand over to Sabrina, who will take you through a much more detailed review financially.

Now, in the second quarter there was a lot of bright spots inside the business that we feel good about.

There's been a lot of effort, a lot of energy, being directed to get us to where we are today.

So I think the best thing for me to do is maybe take you through some of those bright spots and give you my sense of what we're doing, and to give you a little more information behind the P&L.

So let's start with sales, which was very positive in the second quarter.

We had a 4% comp, and that was made up by our three North American brands with 7% comp in Gap North America, 7% Banana Republic, and a 3% comp at Old Navy, and that's the second quarter in a row where the disbursement of our comp was very much driven almost equally across all three of the brands.

That's very positive.

When that happens, our business does very well, as you can see by the $0.49 earnings per share the Company accomplished.

Now, there are a number of reasons why our business has been consistently positive for the first half of this year.

The number one reason is product, and there's been a lot of focus, a lot of effort, starting late last year with our product teams, and I'm really proud of the work they've done in the first half.

Whether that's on the right styles, which obviously we've had great success with so far, typically in the second quarter, the color trend has been good for the industry, but we capitalized on it.

I think we've really focused on fit and consistency of fit, and our scores on that front are improving into the second quarter.

Lastly, we've made these targeted investments in key categories, categories where we want to dominate, where we want to win, and those are our product assets.

We've put the money behind those assets, and our customers are noticing it.

Second thing when it comes to sales, is I think we are flowing our product in a much more seasonally correct way.

One thing that I've always been frustrated about is that July and January, in particular, have never been our best months.

I think the teams are doing a much better job of reacting to that and putting seasonally more correct product that customers want in our stores this past month.

Lastly, I've got to take my hat off to our store teams.

Our store execution in the second quarter was very good.

I was in a lot of stores in the second quarter.

Saw not only the enthusiasm behind our store associates, but I think the standards, the execution, the visual merchandising, the windows were all a step above.

That's been a big contributor to the Company's performance on sales.

Gap Inc.

Direct was up 24%.

That obviously helps when you look at a 4% comp in the second quarter.

That was a good performance by that team.

The only thing that we are focusing on is our traffic was negative.

We know for the business to fire on all cylinders, we not only need to have AUR happening, store execution, the right product investments, but we need to have positive traffic.

So you'll see some further focus in that area in the second half of 2012.

Now, we did end strongly, which I felt great about.

That was a 10% comp in July.

It's been a long time since we've had a double-digit comp like that.

The calendar shift helped a little bit.

We're a very holiday-driven business, with so many outlet stores and Old Navy.

Regardless of that, a 10% comp was a very nice way to end the quarter.

Next, I want to talk about is our international business.

They had a minus 5% comp in Q2, and they expected and we expected a better business.

So let me give you a little further color behind that minus 5% performance.

It's obviously difficult in Europe right now, but where we feel good about our actual store distribution in the European market is we're very concentrated in key cities.

London, Paris, Milan, and Rome is a big percentage of our European business.

As Europe begins a recovery at some point in the future, I think we're positioned properly by being much more dominant in those key cities.

In Japan, this was the first full quarter that anniversaried the disaster of 3/11, and us, like other Japanese retailers, were clearing through spring and summer product as traffic dropped significantly in the Japanese market.

So we are up against that very aggressive clearance quarter.

I believe that will be behind us more in the third quarter and in the fourth quarter, and we have expectations that we'll have a better performance in Japan in the second half.

China's too small right now to be material to our comp number.

Our total sales in the second quarter were up 6%.

Our International business was up 7%, so even though the comp was negative, total sales were up 7% internationally.

Our franchise business up 25%, continues to go from strength to strength.

Athleta opened 11 stores.

I'm going to pause for a second.

That's just a really good number for a young team to execute and deliver on.

I was in a lot of those stores this summer.

I think the store teams have executed well, and customers are responding very positively to have a physical presence of the brand in their neighborhood.

Our global outlet business added 10 stores the second quarter.

That contributed to the 2% spread.

Lastly, we opened up our first Old Navy store outside of North America in Tokyo.

I was there the week after it opened, and was really impressed, not only by how well we translated the brand into a whole new market, but the response of customers, and families in particular, which is the cornerstone of the Old Navy brand, was great to see when I was in Tokyo.

So that will lay a nice groundwork.

We're testing ideas, we're trying different things, but I think that sets us up nicely for the rollout of Old Navy in Japan in 2013.

From a margin perspective, we had a very nice lift in the second quarter.

We are working aggressively on ticket integrity, selling product at full regular price.

I think that's been helpful to us.

That doesn't just happen through great product, although that's the initial first driver.

It happens through where it's in the store, how our store associates sell it, what goes in the window.

It also helps with the marketing investments we are making, we are creating demand on the first day it either shows up online or shows up in the store.

This was the first quarter since late 2011 where our average unit cost, our cost of goods, were not significantly above the year before, and that contributed to the performance.

As a business, we are still very committed to making the right thoughtful investments in our SG&A line.

One is marketing.

Gap North America has been receiving some incremental marketing in the first half of this year, driving the Be Bright campaign.

That has had really good feedback, whether it's online, we've heard through social media, or in our stores, the campaign is resonating.

Our digital investment, like other retailers, we're putting money behind digital.

Whether that's online marketing or other tools, we understand where customers are shopping.

We understand where they're getting their information.

We've done some very good work on that front.

Lastly, some money's gone into store labor.

We've got some service models we're looking at selectively in key stores.

We're testing some ideas.

So I think there's an investment there in the second quarter that helped.

In closing, when you perform and deliver $0.49 in earnings per share, over last year's $0.35, a 40% increase in EPS, of course I think overall people here are energized.

It's a good feeling inside the business.

What I have to do is make sure everybody stays focused, and that's what's critical, is what got us here to this performance.

Let's just keep doing that and keep repeating it.

We mentioned on these call before, where last fall was important moment in the Company to make sure that Gap Inc.

comes out strong at the beginning of 2012, and that's what we've done.

But we know that sustained performance is what matters.

Everybody here is working hard every single day to make sure we maintain the momentum in the back half that we enjoyed in the first half of 2012.

So with that said, let me hand it over to Sabrina, who will take you through the financial results of Q2 2012.

Sabrina?

Thank you, Glenn.

Good afternoon, everyone.

We're very pleased with our second quarter performance, as we again made meaningful progress against our 2012 priorities, including driving increased sales, investing in our business, and growing earnings per share.

Here are some highlights.

Consistent with the first quarter, net sales were up 6%.

Comparable sales were up 4%, and our North American divisions again each posted positive comps.

Operating margin was up 200 basis points, earnings per share grew 40%, and in addition, we generated strong free cash flow and returned approximately $410 million to shareholders through our share repurchases and dividends.

Please turn to slide 4 for our earnings recap.

In the second quarter, operating income was up $91 million or 27%.

Net earnings were up $54 million, and earnings per share were $0.49, up from $0.35 last year.

Turning to slide 5, sales performance.

Second quarter total sales were $3.6 billion, up 6%, with comp sales up 4%.

Total sales and comps by division are listed in our press release.

Turning to slide 6, gross profit.

Gross profit dollars grew by 14% to $1.4 billion.

Second quarter gross margin was up 300 basis points to 39.9%.

Our merchandise margins were up 210 basis points, driven by the combination of growth in average unit retail, and decreases in average unit costs.

Rent and occupancy leveraged 90 basis points.

Turning to inventory on slide 7, as foreshadowed in our July sales press release, inventory per store in terms of dollars was down 6% on last year's up 5%.

Please turn to slide 8 for operating expenses.

We've noted throughout the year that we planned to invest more in our businesses in 2012, and highlighted that it's likely we'll deleverage operating expense.

In line with that framework, second quarter total operating expenses were approximately $1 billion, up $85 million from the prior year.

The increases were focused on our Gap Inc.

Direct division, which grew sales 24% in the quarter; as well as marketing and store payroll investments across our other channels.

Marketing expenses grew $33 million to $147 million, with the biggest increase driven by Gap brand's investment in windows, outdoor, and digital media.

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

Second quarter capital expenditures were $149 million.

With regards to Company-operated stores, we opened 9 stores on a net basis, and ended the quarter with 3035 stores.

Net square footage was down 2% compared to Q2 2011.

Store count and square footage by division are listed in our press release.

Regarding cash and share count on slide 10, year-to-date free cash flow was an inflow of $673 million, and we ended the second quarter with about $2.1 billion in cash and short-term investments.

In the second quarter, we repurchased 13.1 million shares for $349 million, at an average price of $26.65.

We ended the quarter with 479 million shares outstanding.

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

Please turn to slide 11.

Given our progress during the first half of the year, we are raising our estimate for full-year earnings per share, which includes the 53rd week, to $1.95 to $2.

In addition, we are increasing our full-year operating margin guidance from about 10% to about 11%.

As a reminder, it's our objective to drive consistent top line growth while delivering healthy merchandise margins.

A few things to keep in mind regarding our margins.

While our average unit costs are improving in the back half versus 2011, they are not back to 2010 levels.

It's also important to remember that in each quarter of 2011 and through Q1 of 2012, our average unit retail grew as we decreased units in the face of escalating product costs.

Therefore, our plan to introduce more unit inventory in the second half of 2012, primarily at Old Navy, may cause our average unit retail growth to slow compared to the first half of the year.

Regarding inventory, although we plan to add units during the second half, because the cost of each unit is lower, inventory dollars per store at the end of Q3 are expected to be down in the low single digits to last year.

Regarding operating expenses, given the progress we've made on our product, as evidenced by customer response year-to-date, we believe it's prudent to continue to invest in areas like marketing and store payroll.

Specifically, we expect the increase over last year in operating expense in each of the remaining quarters to be at least as large as it was in the second quarter.

As a result, we continue to expect to deleverage operating expense in the second half.

Moving on to cash, our principles remain intact.

Our stated priorities for the uses of cash are first, to reinvest in our business to the degree that we have projects that will deliver appropriate returns; and second, to distribute excess cash to shareholders via dividends and share repurchases.

Given the improvement in our operating performance, we are increasing our full-year capital guidance, and are comfortable spending up to $675 million versus our previous guidance of about $600 million.

Consistent with our strategy, the increase will be focused on remodels that accompany store consolidations and downsizes, as well as other store-related projects.

We also plan to continue repurchasing shares opportunistically, though it's important to note we've consistently stated we expect the level of share repurchase to be more modest in 2012.

Finally, we plan to repay our $360 million term loan.

This repayment, which has no prepayment penalty, will eliminate negative spread, and further support our investment-grade rating.

The following full-year guidance metrics remain unchanged.

Net square footage down by about 1%; Company operated stores, net of repositions, about 130 openings and about 115 closures; depreciation and amortization, about $475 million; effective tax rate, about 39.5%.

In closing, we're pleased with how we executed against our strategies during the first half of the year, and are focused on delivering on our goals for the remainder of the year.

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

That concludes our prepared remarks.

We'll now open up the call to questions, and we'd appreciate limiting your questions to one per person.

Thank you.

(Operator Instructions)

Barbara Wyckoff, Credit Agricole Securities.

Great progress.

Happy to see it.

Can you talk about China and potential expansion in China?

How many stores are you going to open over the next three or four years?

Can you compare some of the metrics on those stores, relative to, say, the US stores or Japan?

It's a little premature to talk out three to four years, what is to say, sort of reminder to everybody in the fall, and we're going to do 30 stores this year.

That's our commitment.

The news within that 30-store profile is that we're going to open up in 5 new cities.

So we'll be in 10 cities at the end of year, which part of our real estate strategy was to go into Beijing, Shanghai, Hong Kong, and then last year we opened up in two other cities which were Tianjin and Guangzhou, and we're going to have more cities by the end of this year.

That's newsworthy, because it allows us to answer your question actually, Barbara, which is, I'm not saying anybody, but brands, if you have a brand positioning globally, you can go into Shanghai, Beijing, and Hong Kong and likely carve yourself up a decent-sized business, but to find out how big can China become, given the fact that it's the second biggest market for apparel in the world, just passed Japan about 12 months ago, we decided to go in and make sure how well can we perform.

Again, to your point on productivity, on return on capital, on overall sales, how can we do in markets that we're going to need to get into and penetrate and be successful in order to have a meaningful business?

So that's important for us to learn that.

Second thing we did, we went with online day one, which we'll have our second anniversary this November.

That was also important to find out how would the Chinese consumers buy online, because it different than it is here in the US, and that's not uncommon.

A lot of countries, the online penetration, the reception of it can be different.

We've been very pleased with our online business.

That's good to our overall strategy.

The third leg, to answer your question in the future, is we're opening three outlet stores this year.

I was actually just in China, and I was really impressed.

I've been to outlet centers before, but I saw our two stores, two of the three that are under construction and the quality of the sites, the quality of the co-tenancy, which is really good for us, you're talking about Coach, and Nike, and people who we actually have nice co-tenancy relations with here in the US.

So I think I was impressed with that.

So the answer, we'll know probably a little bit more at our analyst meeting next year.

We'll be able to figure out more about our strategic plan for China, where that's going to go, but I've always been a believer that that was a great market for us because of our multiple brands, which we have not decided yet beyond Gap we're going to do anything.

The only decision we made so far is one brand with multiple channels, but I've always felt good about the market because of the American component of our brands, and how well that resonates with Chinese consumers.

The last part would be that we do very well, and our marketing is skewed towards the Millennials here in North America, and the version of that in China is the Golden Generation.

I think our marketing, our positioning, what we stand for, what this Company believes in, our brands -- our brand so far has done very well, so more to come, but we're off to a very good start.

John Morris, Bank of Montreal.

Congratulations on really good progress for your team, Glenn.

Wanted to ask a little bit about the plans that you have talked about with respect to taking some of the savings that you've had from lower product costs, cotton and what-not.

You mentioned and touched on this in some of your prepared remarks, but maybe go a little bit deeper where we might expect to see that reinvestment deployed.

I think we've talked about fabric before, you're pointing to labor payroll, and it sounds like marketing.

So knowing those, maybe go deeper on each one of those, and how you see the returns from those investments coming in?

What gives you the confidence that you'll see the returns?

Clearly we see the improvement in product, but more color there would be great.

Thanks.

I'll take them in the order in which you put them forward.

I'd say on the product side which is, and you add together the amount of money that Sabrina and I were comfortable working with our brand presence this year, reinvesting in 2012, given one, a stepped-up level of confidence.

We are nowhere near where we want to be, but we started feeling more confident last fall as we looked towards the spring, and what our teams were able to get done, and some of the changes obviously we made to get the confidence we started to feel internally last fall.

So it started with the product piece, and that's the larger amount of the reinvestment we're making is in product.

You saw some in the spring, and we were able in the spring to get an early read, and we have ways these days to get a little earlier read than we used to.

So I would say that encouraged us to continue on the same path, maybe a bit of a step-up in investment in the third quarter in product, and the fourth quarter would be about the same as the third quarter.

So the majority of this is, if you talk to our teams, and you've heard me say this before, but it's always worth repeating.

To me the success ultimately of us selling product at full price, and driving the kind of AUR performance that we believe we need to have inside of this business, given our brands, starts with having the right styles, and that belongs to our design team, and having the right color.

That's in spite of the move towards a color trend this year.

We were not happy with the colors we put forward last year.

So style, color, fit is critical, which again, our design team and our production team owns.

There was some decisions made on categories that we want to be more dominant in, and I've listed some in the past.

In Gap, it's being dominant in babyGap, being dominant in denim.

That's important for, obviously, Banana Republic, it's in suiting and it's in woven shirts.

So taking some of those categories that we can go out and we can give them the space they need, because if you're going to put investment in quality, that should come down with an investment in inventory, which should come with investment in space in the store, which should come with an investment in the service model inside the store, and lastly an investment in marketing.

So what we've been working on since last fall is the continuum of that, taking a product asset in each one of our brands, and not just putting quality for the sake of putting quality, because in some cases that could be money unnecessarily being spent, but being disciplined how we do it, and then take it all the way through that continuum I just took you through.

So I'd say the difference you'll see in fall and holiday versus spring and summer is some decisions we made on categories that we're able to chase into, or some speed categories where we still think there's an opportunity to ultimately get the goal here, is to drive our value proposition, which is not overpaying for quality.

So putting the quality where it makes sense, and making sure the right ticket price, and driving right-priced sales.

Marketing, early days.

I made mention in my opening comments that there's a metric that Sabrina and I are staring at and going, we'd like to see a little bit more of that, is traffic.

There's no need to unnecessarily beat ourselves up over a 40% increase in EPS, but we are always looking for the next opportunity.

So the marketing piece, and I'm sure people have heard this maybe from other retailers, but as you shift your business model ever so slightly, we're still going to offer value, we're still going to have promotions.

That's important, particularly at Old Navy and in our outlet business, but as we shift marketing, what is the acceptable lag effect until that pool of traffic gets replenished to maybe it's a better quality of pool of traffic?

So Sabrina and I, working with the brand presidents, will make sure those investments, first of all it's good quality marketing.

In the past we have not spent money in marketing, because we weren't happy with it, and our marketing leaders know that if we're happy with the marketing and it makes sense, and it's going to drive traffic, and it's going to inspire customers, we'll put the money behind it.

So I think the Gap will continue to be, I'd say the focus in the back half, Gap brand mostly North America.

As Barbara asked earlier, China will continue to be a focus, because it takes a long time to build your brand in China.

Maybe a little smaller, but still important to us, is Athleta, as we're starting to build that brand, and put the stores out.

After all, a physical store is a manifestation of marketing investment to create the brand.

So back half we're committed to it.

First call in February, we said we'd take it quarter-by-quarter, but now that we've seen, and we look at a lot of research besides traffic.

We're feeling comfortable about the back half, about some investment in marketing.

The labor piece, that's one I tried to say in the opening call, it's really just some tests we're doing right now in our labor modeling.

We made some tough decisions on labor during the heights of the recession in 2008, 2009, and we know that ultimately our store environment, our store experience, is critical.

Whether that's the capital investments we're making, the right ones, but also labor investments.

I would say that's more predominant inside of Banana Republic and Gap, and more predominant inside big markets.

So you look at the top 10 DMAs, you look at those two big brands, and that's where the labor tests and trying to step up our service model is taking place.

Very comprehensive, thank you.

(Operator Instructions)

Brian Tunick, JPMorgan.

Congrats on the improvement.

Glenn, we know we're still a month away from the new Old Navy president starting, but wondering if you can give some of your thoughts of how you thought the 2Q numbers looked at that business?

Then how you think that the brand is positioned today, and what's your hopes, maybe a year from now, of what you and the new president can do for the positioning, and also what he brings to the overall Company?

Thanks very much.

Well, I have a lot of thoughts on that, but I'm going to try to keep it short.

Because obviously for the Company to step up and hire somebody as impressive as Stefan from such a company that we respect, like H&M, is because we do believe through multiple meetings with him in the spring, before we made the decision he was going to join us, we liked how he was thinking about retail, about product, about winning, and what he's done in his past and his global experience.

So as I said in a previous call, we're just very excited for him to join us in October.

In advance of him joining us, and I'll get back to him in a second, I'm quite pleased with what Nancy Green and Tom Sands have done.

You've got to give them credit.

A lot of times at retail, when a leader leaves, businesses tend to sort of stay status quo, in some cases even flounder, because leadership changes can be impactful on a brand, and so kudos to them.

I've stepped in to help out as much as I can, but they've really led that business and that team.

I'd say the thing that they've been doing is, I think that they've been really cleaning up and keeping the business simple, because I'm a big fan of taking on new initiatives in the business, and at times we may take on a little bit too much, and Old Navy's cleaned that up.

They've gotten very focused on three initiatives.

That's all they talk about.

I'm not going to share those on the phone, but just three key focuses that whole business had, and that's what they've brought.

Another thing I will add, I believe our agency and our marketing team, which right now Michelle Demartini is overseeing for us, she's one of our most senior merchants.

Our marketing at Old Navy, which I love the positioning of the brand, we've talked about, that has not changed since I've been here, but the new platform and how to communicate the voice of the brand has really been good.

I've been pleased.

Since June, you're seeing their business, and I think that's helping their business quite a bit.

I mean, obviously it starts with product like every other brand, but more than any other brand, I think their marketing has really resonated with their customers, and I've been very happy with that.

What's Stefan going to do?

In fairness to him, he's had many, many months to think about it, but until he gets here and meets the team and works with them and figures out whether what he believes strategically he's going to do matches up with what the team is able to get done, it's a little too soon to tell.

I do know, and it's just an inappropriate forum to share it with you, I do know what his vision is, having talked to him back in May.

Obviously he's away from us until October, but the last time I talked to him, whatever it was, six month ago, four months ago, I know that he definitely has a vision what he wants to do.

So we'll see how that plays out and translates inside of our business.

I want to make sure one thing, it's important to me to make clear.

His coming into the business was not driven by the most recent global ambitions we had for the brand.

That's a given.

He opened a number of the countries at H&M, obviously they're a global retailer like Gap is, a global brand that is.

So that I think is icing on the cake.

I believe he's going to come in with a very strong perspective and position when it comes to product.

That's what he knows, having worked in that business.

So that's not taking Old Navy to H&M, because he understands the difference, but I believe he's going to really help us between the design conceptually, to the merchandising, to the process, to the cost part, all the way to in-store execution.

That part of Old Navy he is going to be super strong at, and the global piece will come over time.

We've only got one store in Japan.

That'll just be a nice story to talk about in two, three, four years from now.

Dorothy Lackner, Caris and Company.

Congratulations also on the great quarter.

Question for Sabrina, you gave us a lot of detail about how you're looking at gross margin and the various components, particularly on the merchandise margin side in the second half of the year.

I know you'd said after first quarter don't expect that kind of leverage on rent and occupancy that we saw in the first quarter, and we didn't in second quarter.

So my question is, how should we look at that component of gross margin in the second half?

Thanks.

Are you talking about, Dorothy, the ROD component in particular?

Yes.

To try to be helpful, because we don't guide explicitly to ROD, I did take note, as you mentioned in the first quarter, that that was an unusually high amount of leverage, and it would be not prudent in our view to extrapolate that.

Sure enough, the ROD leverage with the same level of comp of plus 4%, was 90 basis points in Q2.

There are many variables that we've talked about, that quarter-to-quarter can impact ROD including the timing of our store openings, settlements with landlords, when amendments come through.

So there's a lot of variables, but what I would say is the Q2 relationship to that level of comp is certainly a more appropriate level than we saw in Q1.

So that would be a good starting point to think about it for the rest of the year.

Randy Konik, Jefferies & Company.

Obviously your tone's very upbeat.

Where did you think that you have to, where you could have improved during the quarter to get to that next level for the Company?

It looks like obviously you're going to start to grow again here, and it feels like a more sustainable basis.

Where do you think the organization at this size can grow if we think about a normalized growth rate?

And then lastly, what's your long-term vision for Athleta, and do you think we're going to get some more concrete long-term vision on what you think, how big you think that organization can be at your analyst meeting in the fall?

I'd say the first one, Randy, is something, to be repetitive, is something I said to John.

I think traffic number was a number, and I'm not here to rank necessarily all the metrics in order, but you know the Company, and a lot of people on the phone do, we're never really happy.

I think that our team has definitely embraced that sentiment.

This is a quarter where we celebrate a few small wins, and we had some small wins that the team executed well.

We're particularly pleased, as I said in my opening comments, coming off last year, where we were not at all happy with the business, even though there was some circumstances outside of our control, we just weren't happy.

Traffic is a number that we would prefer to not see negative.

It's a number that we do look at holistically between our specialty business, our outlet business, and our online business.

If you look at it holistically, it's probably a different picture, but at the end of the day our store traffic being negative in the quarter is something that all of our teams, our store leaders, our brand presidents, all know that in order to be happy as a business, we'd like to see all our metrics in positive territory, with the exception of AUC.

So that's just the way we have to start looking at the business, but we also know that business' comp is an outcome.

How you get to comp is by taking certain strategies and really trying to take them deep.

So this is just hypothetical, but maybe one brand is working more on AT, one brand is working more on units per transaction, one brand may be working on more on AUR.

They have to pick the metric that supports their overall strategies.

As long as the key metrics they're trying to move in a positive direction to get to an outcome like comp is the framework of their performance, is meeting what they tell is they're going to do, then Sabrina and I are happy.

But yes, we're always looking for -- knowing this business as well as I do now, coming from obviously different industries, what I do know is a metric that is going really well for you for a period of time, you'd be foolish to count on it for a number of years.

So you always have to make sure there's other metrics that can get to the outcome of comp, that you're putting plans in place to strengthen them, because one of the outcomes we're trying to get, to your second question, can we grow long-term.

It's obviously our goal.

So when I think of growth, one thing I do want to put forward, only because it's a number I asked Katrina for the other day, is in Q2 2011, we had 163 more stores than we do today.

By that I mean we closed 163 stores between Q2 '11 and Q2 '12.

So when you think of growth, I always think comp is a metric that everybody should look at, but I'm all about top-line sales.

So that's a number we've said publicly that we are closer to the end of our real estate strategy, which involves closing down square footage, that it's unnecessary, consolidation from kids and baby, particularly in Gap, and to adult, and also closing stores.

We've done more, we have more to do, but we've done more in the last three years.

So we're closer to the end than the beginning.

That will certainly help top-line growth, and that's a number that's important to me.

Comp plus spread equals total sales, and while I have huge appreciation for comp, I've always been about top-line sales.

So I think growth will look more promising in the future when we get to the end of executing our real estate strategy.

Lastly, Athleta you heard me pause on my opening comments.

I mean, 11 stores in one quarter to a team that 18 months ago didn't have a store, it's pretty impressive when you think about it.

Some people obviously opened 150, 200 stores in a quarter, but for that team to come where they've come, and I've been to a lot of real estate, to hear the comments from customers in particular who wanted a physical manifestation of that brand.

I'm very proud of that team in Petaluma, led by Scott Key.

They've done a great job, and this is early days.

We'll have a lot to tell you in the spring of what our plans for 2013, but we will open our 25 stores in 2012, feel good about it right now.

Great customer response.

I think that they think, and I'm more willing to support them than not, although it's early days, -- they feel they got a little bit of a tiger by the tail.

Let's let them feel that way.

Nothing wrong with a little bit of confidence from our latest brand.

A lot more to talk about from Athleta in our meetings in the spring.

Evren Kopelman, Wells Fargo Securities.

I wanted to ask about the Gap outlet channel.

Maybe we see, I think a lot of the time, more of the time, the products in the full-priced stores and the marketing.

Can you talk about the products and marketing initiatives for the outlet stores, and how store traffic there?

Is it also negative?

How many stores are you at now, and where do you expect the growth there to be?

Thanks.

Thanks for asking about outlet, because I can talk about that business.

Again, like I said with the Athleta, I'm very pleased and proud of our two leaders, Ann Doyle and Andi Owen, who run our two factory store outlet businesses.

Is the traffic better there than a specialty store?

The answer is yes.

So that's why said earlier that if you take specialty plus outlet plus online, and then bring that together as one traffic number, our traffic's actually not that bad.

But we have to look at it channel by channel by channel.

Our outlet channel is, definitely the traffic's better.

So that's good.

I think that's a little bit about the overall traffic that is in that genre of real estate.

The other thing is our teams, I'm glad you mentioned marketing, our team is actually, again from a team that had no marketing when I started here, and don't have a big marketing budget, but they're very scrappy and smart about how they spend their marketing.

And they have great customer connections, whether that's through e-mails or through some of the partnerships they've done.

So I think the marketing there, which is not a big driver of this increase in our SG&A, but they are getting a little bit more marketing than they have in the past, and they're making good use of it.

What we don't talk about, and I think everybody on the phone always wants to focus on our specialty business, particularly Gap, which I understand, but the product improvement in the outlet channel has been at a minimum equal, if not some people may argue better, but the step-up in the product and the investments, what they've done there has been great.

Very, very impressed.

I'm in those stores a lot.

I'll be out on Friday in some of them.

So those merchant teams, those marketing teams, under that leadership of a channel which we feel we have a competitive advantage in, we will continue to drive globally, is nothing short of impressive.

So it's good to see, and we have high expectations for them going forward.

They're off also to a very good start so far this year.

Adrienne Tennant, Janney Capital Markets.

Let me add my congratulations as well.

It sounds like you're happy with the Old Navy television advertising.

I was wondering if there are any changes to the fall season marketing plan for Old Navy, and if you'll be adding Gap TV back?

Then Sabrina, just a clarifying question.

On your operating expense guidance, was that year-over-year or was that by percentage of sales?

On Old Navy, as far as I know, I think there may one less week of television in the third quarter.

But what I'm happy about is that, as you put this new platform together, back whatever it's been now, just less than a year.

I'm really liking the new creative.

So if people, which is our core customer, are responding positively to what they've seen over the last couple of months, which I think has really helped their traffic profile.

Let's see what transpires in the fall and holiday.

I think that the messaging, how it resonates, how well the creative is showing the product goes back to what I said earlier, if you make investment in product, it has to have a follow-up investment in store space and service model, and ultimately marketing has to show the investment you're making in your product.

I think Old Navy team has done a really good job of that.

So has our agency.

So maybe one less week, but I think it's better quality of marketing that we're putting out there.

I just saw the holiday and the Thanksgiving ideas the team has, and I actually feel really good about it.

It's a lot of work still to be done, but they've put forward not only good Q3 ideas, but I think the early ideas behind Q4 certainly motivate me to make sure that their spend stays, at a minimum, equal to last year.

So I think that's good.

Then to clarify, Adrienne, thanks for asking the question.

What we meant is in the second quarter, operating expenses were up $85 million.

That translates to about 9% increase over LY.

So we mean that in Q3 and Q4, you'd expect at least a 9% increase in operating expenses over last year's quarters.

Okay, perfect.

Then Gap TV?

No plans right now.

I think one thing you should look for this fall, as our new campaign just came out, is we did shoot some film of the New Icons Redefined campaign, which supports Be Bright, so it's the fall campaign for the Be Bright platform.

We're going to be in cinema with that, and definitely on social media.

I think it's some of the better work we've also done.

So is there television in Gap's future?

Maybe.

I mean, we never said we'd never do it, but at the same time, right now we're very happy with the mediums we're using.

We're being very effective, and digital's been a great medium for us.

Like our new marketing team, our team here in San Francisco, our teams around the world, and our teams in New York really have embraced digital.

If you can get great content and use digital, I think that can be very effective, too.

So if you do get a chance in the next week or so to see some of the film that was done, and the content, it's really well done.

It supports the brand, and I think it resonates very strongly.

Could that lead to television?

Only time will tell.

Great, wonderful.

Good luck.

Betty Chen, Wedbush Morgan Securities.

Congratulations on a great quarter.

Glenn, I was hoping you can talk a little bit more about the core product categories for each of the brands.

I know that you had mentioned that the team is certainly focusing behind them in terms of style and fit and many of the other categories to make sure that the consumers continue to really be compelled to buy them at the right price.

I was curious on so far, now that we've got two quarters down, how do you think about how is the team executing in those core categories, in your opinion?

How is the team able to get earlier reads, as you had mentioned, I think earlier in the call?

What are some of the methods you're using?

Then lastly, I was just thinking in terms of the international business, certainly we're going after many of the markets with different business models.

Now that we're still early on, but now that we're in some of these markets, have your thinking in terms of how you're going into these markets varied at all?

Can we look for some changes in the future?

Thanks.

Okay.

Seems to be the day of three questions.

So on the first one, what I do feel good about is that the stepped-up performance in our top-line sales, for the most part, has been driven by the categories we identified to make some reinvestments in.

I think I was giving my theory on comp earlier.

The same thing applies to product.

Comp is an outcome.

If you have a 4% comp, like we did in the second quarter across our multiple brands, that was a 7% in Gap, a 7% in Banana Republic, a 3% at Old Navy.

Let's just take Banana Republic for now.

So you had a 7% comp.

To get to that, the team has to plan certain categories they really believe in, want to invest, and all the reasons I gave earlier, try to get a 10% comp in that business, a 12% comp, because if you try to get everything at a 7%, you're going to make some mistakes, and the outcome will not be a 7%.

So what I do like about the business so far is where they decided to stand behind what they believed in.

This is not new, we've always had categories where we want highly competitive advantage in, want to be dominant in our competitive set, and want to therefore define product assets.

Those have not totally changed since I've been here.

We've just been more focused on them.

This next leg was putting some money behind it, and I think that's really worked out.

I think the comp numbers are being driven in a larger way by those categories we believe in.

Early reads, all of our stores, we don't have a model like some other businesses, but the early reads, where they help us, whether we're doing it through social media, by getting some early reads on product that's not quite bought, which has been a helpful tool to us, or finding a way, as product goes on our online site earlier than it goes on our store, get an early read so we can chase-in.

That's the most effective form of speed we can do.

Early read, either through, again, by crowd sourcing, let's call it for lack of a better word, and getting some feedback to help us better understand if that's the right product, whether it's a pattern, a print, a color, a style.

When you really get in season, that's when I get excited.

You get a real early read online, and we quickly, through the fabric platforming we've done, be able to chase back in, in a very short period of time, back into goods that are going to be in our stores more than six weeks.

That's a process that we've been talking about in these calls for a number of years.

We slowed speed down last year, and chased down, because with cotton being so unpredictable, we didn't want to have a -- change our business model too aggressively in 2011.

In '12 now, we've pushed our teams, and they've absolutely embraced the fact that there's a way to get some early reads that we have probably not used in our past, and be able to react more quickly.

So faster pipeline, a speed pipeline, and a way to get feedback from either a form of crowd sourcing, or immediately through an online channel, and then reacting to it much faster than we used to, that's in the early days, but it's helping us.

Last part, in the international formats we use, the only thing we ever said, and I don't think we'd ever changed any market we went corporate in, and we wouldn't change any market we've gone franchise in.

The only think we've ever said is as we look forward, are there markets we'd consider joint venture?

We don't want to take that off the table.

That may be an option.

Look at a market like India, if we were to consider that at some point in the future, the only way to go into India right now is through a joint venture.

So we're not against that.

If our franchisees want it to turn into joint venture, if there's a franchise opportunity to go to corporate.

We're not looking at those today, but I would say as our business continues to evolve, and we look at our performance, we don't want to be completely married to the format we have, but there isn't a single decision we made so far to go franchise in a country that we would ever change.

I think every one of those was a good decision.

There isn't a single corporate country where we went into, we are in today, we'd ever turn the franchise.

So for the most part, what we've done so far is we're going to stick with, but let's look at the next two, three, four years and see if there's any change to the franchise relationships we have.

I doubt it, but I'm just sort of saying, that would be the only way we change any relationship that we currently have in a market.

Thank you, and best of luck.

Paul Lejuez, Nomura Securities.

Glenn, you talked about traffic being down.

Can you just clarify, was traffic down at each brand?

Regardless of the answer there, can you maybe talk about what the comp drivers were at each of the brands, whether it be conversion, AUR, UPT, and how that might be likely to change as we move into the second half?

Thanks.

I think you answered your first question rightly, because I can't give it out by brand.

We were just giving you a total across-the-business number.

Sabrina can shed some light definitely on all the different metrics.

I have the metrics, and what I can say to you before I hand it to her, is to repeat something I said earlier, which is important.

Our teams definitely realize that you have to be able to look a little deeper into their business and say, where do I want to drive something across some of the different metrics you mentioned, to get to the right outcome?

At the same time, they're always looking in the rear view mirror and going, what are some other metrics they may want to strengthen?

Because something could happen, UPT, that's not of our making, whether it's economy or macro events.

So they're always trying to find a way to make sure that the delta between our highest performing metric and our worst performing metric is not too wide.

In our past, that's been a problem we've had.

Here they're trying to make sure that they tighten that up.

I'll let Sabrina give you some color on the metrics.

Just a little bit more color on traffic, because Glenn's been talking about that a bit.

As he mentioned, Gap outlet in particular, but the outlet and Old Navy relative to the other divisions, I think it's fair to say that value segment has had better traffic than the specialty segment, broadly speaking on traffic.

With regard to the other comp lever metrics, we don't go division by division, but it's generally true that average unit retails being up, and conversion being up, are the two strongest metrics that drove their performance across the quarter.

Lorraine Hutchinson, Bank of America Merrill Lynch.

I just wanted to follow up on the operating margin guidance of 11%.

You're running nicely above that year-to-date.

I understand there are some investments to continue to be made, but what are the drivers that would cause the operating margin to fall below 11% to get to your full-year target in the back half?

There's just a lot of scenarios we run.

I think we landed on about 11%, because of the architecture of how we're looking at how the year will unfold.

We obviously have said it is our primary objective to drive consistent top line growth with healthy merchandise margins.

So we definitely want to see that nice expansion.

Offsetting some of that, we've tried to be very clear that we expect deleverage on operating expenses.

So between that combination is how we get to about 11%.

What we're pleased with is we started the year with about 10% guidance, and it's obviously another objective of ours to expand our operating margin back over time.

So this is a nice step-up, standing here in Q2 that we feel comfortable bringing it up a whole point.

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

As a reminder, our earnings press release, which is available on gapinc.com contains a full recap of our Q2 results, as well as the forward-looking guidance included in Sabrina's remarks.

As always, the Investor Relations team will be available after the call for further questions.

Thank you.

Ladies and gentlemen, thank you for your participation in today's Gap Inc.

second-quarter 2012 conference call.

You may now disconnect.