蓋璞 (GPS) 2013 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen, my name is Amber, and I will be your conference operator today.

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

first quarter 2013 conference call.

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

(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 first quarter 2013 earnings conference call.

For those of you participating in the webcast, please turn to slides 2 and 3. 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 which is available on gapinc.com.

These forward-looking statements are based on information as of May 23, 2013, 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 would like to turn the call over to Glenn.

Thank you, Katrina, and good afternoon, everybody.

Before I hand the call over to Sabrina who will take you through the Q1 financial highlights, I want to take you through how we as a business are looking at the first quarter, and also want to give you an update on our key initiatives for 2013.

The one thing that comes to mind when I think about Q1 was the consumer, that we have been operating pretty much for the last five-plus years in a very challenging environment.

And this is the first quarter in a long time that I think the consumer to us felt like they were moving in a positive direction.

Things are still challenging, but they are starting to feel a little bit better for a lot of reasons, and I am sure we have already about or know about.

So I would like to think that, that is a good sign as we look forward to the rest of the year.

Obviously the news story is that we were able to get a two comp in Q1 2013, on top of the four comp we had in 2012, also known as comp to comp.

Last year was obviously a good performance for the business driven by the investments we made in product and in marketing.

There was a little bit of weather help in 2012, and there was a color trend, but I think our teams came out very strongly in this first quarter.

And I think it is nice to see across all of our businesses, a good two year comp performance in our three key brands.

Now to me the big driver of that continues to be our product, and we continue to have good product momentum.

Now comp is an outcome, and all of our merchants and designers and marketers and our brand presidents know it takes good strategic thinking on where we are going to dominate and where we are going to differentiate in each one of our categories, that builds up to a comp.

So when I look at the quarter, and I look at categories at Banana Republic and Gap and Old Navy, the ones that drove over and above performance were the categories that we are putting a lot of time, effort, and money behind, because we think we can get market share gains.

We can get an edge, and we can get more customers to engage with our brands, by showing that these are the categories, whether it is suiting, whether it is bottoms, whether it is dresses, these are the categories that are going to differentiate ourselves against our competitors.

And lastly in the quarter, just one more number I want to talk about was, online had a 27% gain in revenue.

And that is key to us.

Everybody who knows our business, in multiple channels -- outlet, specialty, franchise, and in particular online -- is really a key strategic initiative.

So up 27%, while the majority of that base is in the United States, we are seeing really strong growth in Canada, Europe, China, and now in Japan.

So let me just pivot for second and talk about our strategic initiatives.

First and foremost, it is about growth, how the Company is going to grow, what new initiatives we have going on.

We have been clear about where we are putting our investments in our February call.

We reiterated that in our Investor meeting in April.

Franchise store count is on track.

We feel good about the countries we are going to enter.

We feel good about the balance between Banana Republic and Gap, our global outlet openings.

Everything is coming together on that front.

Again, multiple country openings.

Openings here, in Canada, and Japan and Europe, and I was just in China to see the fifth store open.

That is a good opening for that very important channel in this most important of countries.

China, everything is going well.

That team just continues to impress me.

They have an aggressive agenda for 2013.

For one, they are prepared, and the consumer and the environment is just right for us in China.

So I think everything there is all systems go.

Old Navy Japan, we opened nine stores in Q1.

So unlike most real estate, as has been my experience in the years I have been doing this, real estate tends to be back-end loaded.

So I was very proud of the team, that they opened so many stores up in the first quarter.

And I am going to be going there the end of June.

But for all intents and purposes, look at the numbers, the customer feedback, the launch strategy, that is really impressive to see that, and that really gives us great confidence going forward.

Intermix is on track and Athleta openings are on track.

There are absolutely executing as we would expect in these two developing brands.

We feel good about the prospects for the rest of the year.

The last thing from our strategic initiatives, I do want touch on is omni-channel.

In the quarter we launched ship-from-store for Old Navy.

All of Gap is now on ship-from-store, Banana Republic was in 2012.

We are easing our way into getting more stores and more categories on, but the launch has been smooth.

The store execution has been great.

So this whole idea between a customer now going online, and seeing that everything is available.

As we have talked about many times, the psychological impact of showing an out of stock online, the majority of our customers when they see an out of stock online, something not available, not in their size, not in the right color.

Then they assume it is not available in the store.

So that is just from a marketing perspective, huge value to us.

But also the ability now to use our pools of inventory seamlessly, and to take something from a store, and ship it to an online customer, it is really just a preliminary step on this amazing continuum we have for the omni-channel.

We will be launching reserve-in-store next month.

That is in Banana Republic and Gap.

It is a pilot.

But again, the ability for a customer to seamlessly engage with our business, to go online, see something that they love, reserve it.

Get down to the store, hopefully buy more, have an amazing customer experience, I think it is good for loyalty.

It's the next step along our path to get to a true competitive advantage, and differentiation in the marketplace by acknowledging that the way to win these days is with great product, compelling marketing, and giving customers access to your business anywhere they want.

That is why we call it easy-buy-anywhere.

With all that said, as I said in the press release, we are pleased with our first quarter.

It is nice to get off to a good start.

The first week of every month, the first month of every quarter, and the first quarter of every year are very important.

So it is good that we got off to a good start, in this first quarter of a new fiscal year.

I am going to hand it over now to Sabrina, who will take you through the financial highlights.

Sabrina?

Thank you, Glenn.

Good afternoon, everyone.

Our first quarter performance represents meaningful progress against our 2013 financial goals, which include growing sales with healthy merchandise margins, managing our expenses in a disciplined manner, and delivering operating margin expansion and earnings per share growth.

Please turn to slide 4 for our earnings recap.

Our earnings per share for the quarter were $0.71 versus $0.47 last year.

However, it is important to note that of the 51% earnings per share growth in Q1, about half was due to the benefits from the calendar shift, and from the favorable resolution of tax issues.

That said, we are pleased with our underlying operating performance for the quarter.

Here are some highlights.

Net sales were up 7%.

Comparable sales were up 2%.

Operating income increased by $135 million or 34%, and operating margin expanded by 290 basis points to 14.2%.

Net earnings were up $100 million or 43%.

Turning to slide 5, sales performance.

First quarter total sales were $3.7 billion, up 7%, with comp sales up 2%.

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

Of 5 percentage point spread between total sales growth and comp sales growth, about half was due to the impact of the calendar shift created by the 53rd week in fiscal year 2012.

As a reminder, this year's first quarter dropped a small week in February, and added a much larger more full price selling week in May.

The translation of foreign revenues into dollars negatively impacted our reported net sales by about $45 million in the first quarter.

This translation impact was primarily due to the weakening of the Japanese yen versus the US dollar.

In fiscal Q1 2013, the average exchange rate of the yen was roughly 18% less than for fiscal Q1 2012, or JPY80 last year versus JPY95 to the dollar this year.

Turning to slide 6, gross profit.

Gross profit dollars grew by 12% to $1.5 billion, and gross margin was up 200 basis points to 41.4%.

Our merchandise margins were up 160 basis points, largely driven by decreases in average unit costs.

And rent and occupancy leveraged 40 basis points.

Please turn to slide 7 for operating expenses.

First quarter total operating expenses were $1 billion, up $34 million from the prior year.

Marketing expenses grew modestly by $4 million to $143 million.

As a percentage of sales, total operating expenses leveraged by 90 basis points.

Expense leverage also benefited from the calendar shift in the quarter.

Therefore, we would caution against extrapolating this magnitude of leverage to future quarters.

Delivering on our goals of sales growth and expense leverage resulted in net earnings of $333 million, up 43% to last year.

As I have mentioned, our earnings in the quarter included about $0.04 of benefit related to the favorable resolution of tax issues in the first quarter.

About $18 million of the benefit is reflected in interest and the other $0.02 of benefit to EPS are reflected in the tax rate.

Moving to the balance sheet, on slide 8. Inventory dollars per store were up 3%, broadly in line with our comp sales growth.

The plus 3% is on last year's 7% decrease in inventory dollars per store.

For the quarter, free cash flow was an inflow of $205 million, roughly equal to last year.

We ended with about $1.6 billion in cash, and we distributed $128 million through share repurchases and dividends.

Our quarter end share count was 466 million.

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

First quarter capital expenditures were $151 million.

With regard to Company-operated stores, we opened 10 stores on a net basis, and ended the quarter with 3,105 stores.

Square footage was up 0.3% compared to Q1 2012.

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

And now I would like to share our outlook for the rest of the year.

Please turn to slide 10.

As we said in our April sales recording, our first quarter operating performance was broadly in line with our expectations at the time we provided our full-year guidance in February.

Therefore, nothing has meaningfully changed in our full-year outlook.

And we are reaffirming our full-year earnings per share guidance of $2.52 to $2.60.

To be helpful, there are two important considerations for the remainder of the year.

First, as we told you on our Q4 call, our full-year earnings guidance contemplated some of the impact of foreign currency headwinds, specifically the weakening yen.

Since we provided guidance in February, the spot rate for the yen has weakened by about another 10%.

The average spot rate for the yen last year was about JPY80.

Current spot rate is about JPY103 or about 29% depreciation.

This depreciation negatively impacts our reported sales and earnings, as our local currency results translate into fewer dollars.

Second, as we noted several times the fourth quarter this year has one less selling week than the fourth quarter last year.

Additionally, the fourth quarter of 2013 drops a large fall selling week.

Therefore, just as the first quarter benefited from the calendar shift, the fourth quarter is expected to be negatively impacted by an amount that is at least as large as the benefit we saw in Q1.

For the full-year, the following guidance metrics remained substantially unchanged.

Operating margin about 13%.

Square footage up about 1%.

Regarding Company-operated stores net of repositions, we plan to open about 160 and close about 80.

Store openings are weighted towards Gap China, Old Navy Japan, Athleta and global outlets, while store closures are weighted for Gap North America.

We expect capital expenditures to be about $675 million, and depreciation and amortization to be about $475 million.

We expect our full-year effective tax rate to be about 39%.

We expect Q2 inventory dollars per store to be up in the mid single digits.

In closing, we are pleased with how we executed against our strategies in Q1.

In particular, driving a positive comp and revenue growth on top of last year's strong performance.

Of course, now we are focused on delivering our goals for the remainder of the year.

Thank you, and now I will turn it back over to Katrina.

That concludes our prepared remarks.

We will now open up the call to questions.

We would appreciate limiting your questions to one per person.

(Operator Instructions)

And we will go first to John Morris, BMO.

Congratulations, everybody on a great start to the year.

I guess, maybe Glenn, you talked really effectively, you and your team when we had the Investor Day about the seamless inventory initiative, which you touched on this morning in your prepared remarks.

It sounds like it is rolling forward maybe a little bit faster and into place than some of us might expect, which is great.

I am wondering if you can talk a little bit more about the performance contribution potential you might see coming from that?

I know it is hard to predict, but maybe it is helpful to think about it relative to some of the global competitors who have some of those initiatives already in place, that you would probably know about.

Okay, John, I would say there was really two parts that we talked about in April.

So and just for a -- from a terminology perspective, is a seamless inventory.

And the idea behind that -- and that is going to take a little bit longer.

That is more of a mid term opportunity for the Company.

The idea behind seamless inventory is right now, as a Company -- and this is true of almost every single apparel Company, with likely the exception of Inditex -- that we have inventory that is either in a country -- and that -- well, it is inside of a country like Japan, that it is inside of a distribution center that is online, inside of a distribution center that could be for stores, and that it is inside of our 150 stores in Japan.

So the idea behind this is, how do we, with the systems that were put in place now and some changes in process, how do we make sure that our inventory becomes seamless?

So when it leaves a factory from a vendor, that a 100,000 unit PO that was agreed to weeks before that, just before it leaves, it goes to the most appropriate country where it makes the most sense.

Where we can maximize our sales and maximize our gross margin dollars, because it is matching supply with demand.

And when it gets inside the country, again how do we make it seamless between -- and let's assume that you have a single distribution center, that would make a big difference for us.

And then, when it gets inside of that distribution center, how do we make sure it is seamless between the online channel and the stores?

So that is a project that we have already done some work on.

We are building the base.

I think that is going to be more of a 2014 and beyond opportunity.

The other part that could be I guess, be viewed as seamless inventory is what we are calling a more responsive supply chain.

And that is really, us as a business.

And this is something that, in hindsight I probably should have pushed a little more aggressively inside the Company.

But we have told people in the past, that our supply chain needs -- in order to become more responsive, it needs to be built on having much more fabric platformed inside of all our mill relationships.

Once you have fabric platformed, then you can do -- you can be a lot quicker on basic inventory, and seasonal basic inventory, to get a read and respond.

And we have done some of this, and there is some of that going on in the Company today.

But I guess, if I was to characterize it, if what we consider to be world-class, we are probably the second inning from being -- from a standing start, we are probably in the second inning right now, of actually getting to a more responsive supply chain.

Some of that will happen in 2013 a little bit.

But again, most of the benefit from changing how we operate, changing the brands' operating model, to be a much more of responsive supply chain will happen in 2014.

Glenn, are those potentially contributors in the hundreds of basis points over time, just order of magnitude of benefit?

It is tough to quantify.

Always said, John, before is that the people with the highest operating margin in our industry are in the high teens.

And we are in the -- call it for argument's sake, the mid teens.

And some of that difference, not all of it, some of that difference is that they have embraced a more seamless inventory management operating model, and their business was built on a responsive supply chain.

So we are different businesses than the leaders when it comes to operating margin.

But I think there is definitely some application for us, that we are -- and some of it is in place now, but a lot more to come.

But it certainly doesn't explain the whole delta of 400 or 500 basis point difference between ourselves and the leading Company in our sector.

But I think there is some differences.

There is some of that can be explained through the fact that we haven't embraced ourselves, those two opportunities.

So more to come, and we will see if we can get it in place for 2014, but there is certainly value attached to it.

I just can't quantify it for you today.

Very helpful, thank you.

(Operator Instructions)

Your next question comes from Kimberly Greenberger with Morgan Stanley.

Oh, great.

Thank you.

I will add my congratulations as well to a really terrific quarter.

Glenn, when you think about the operating margin opportunity from some of these strategic goals, maybe you could just rank order them, in terms of where you think the greatest profit opportunity upside might be?

Is it the seamless inventory or the more responsive supply chain?

And over the next sort of year or two, do you think you have got an opportunity to further lower your average unit costs, or are you sort of seeing some stabilization there with perhaps some wage pressure creep into either late 2013 or 2014 costs?

Yes, I guess, there is two parts.

So if I focus exclusively on average unit cost, the opportunity clearly for us is to use less fabrics in the business, and have people -- our vendors are becoming more and more sophisticated.

And they are spending money and equipment, and they are able to take a fabric now, and do multiple things through washing and treating it, that they couldn't have done five years ago.

So I think that having fewer fabrics inside each one of our brands, and committing for a longer period of time, let's call it for a year or more, to that fabric, I think still gives our designers and our merchants huge flexibility to do the right thing on product.

We are not quite to sacrifice anything for efficiency, to not give them the ability to do the right products in all the categories I talked about earlier.

But I think it is clear to us now, that we can reduce that, give our sourcing team the ability to work with the mills, having less fabrics, and going for longer commitments.

I think there is value in that to be unlocked inside the Company.

Whether that value can offset the wage pressures and everything else that is going on in everybody's supply chain, that is to be determined.

I am just happy that, as I stated probably five years ago, I am just happy we still have lots of opportunities to improve the business from a -- either a cost perspective or from an earnings perspective -- because what I am identifying here, from an AUC, is something that we do today.

We just don't do it as much as we should, and the Company has always had lots of priorities.

The great thing about Gap Inc.

is we are rich with opportunities.

And this is just one we talked about before, that I believe we can do a lot more with this.

And our vendors agree, and I was -- they know this, I was with all of them.

I spent ten days in March and Korea and China and India.

So I was speaking to them about how much more we can do, explain to them our plan, trying to quantify the value of that.

So our team is working aggressively to get that one component done.

On your first question, it is tough to rank them, Kimberly.

What I would say, is there is three opportunities we spoke about at our Investor meeting in April -- I apologize to anyone on the phone who wasn't there.

But we talked about the omni-channel opportunity, which I think there is value unlocking it for sure, and we are pretty far ahead.

And there is lots of components to the omni-channel that should generate real value.

And the value I am looking for is in the sales line and in the market share opportunity.

And then are the two I just talked to John.

So ranking them is difficult.

I think all three have contribution and value to be unlocked between the three of them.

And the only thing I would add to it is, not much difference between the three.

So there isn't that one is worth a lot, and the other one is just a marketing term that we are using -- and because we want to look like we have opportunities.

All three have opportunities and value to be unlocked.

But I just say they are all equal for now, until we actually get them in place, and get a read from our customers, and see what it can generate, in terms of earnings -- incremental earnings for the Company.

So we are fortunate to have all three of those opportunities available to us.

Great, thank you.

We will go next to Matt McClintock with Barclays.

Hi, good afternoon, and congratulations on out-comping the comp.

So essentially, I have one question.

You talked about 27% online growth, and that really is outstanding, particularly given the size of the overall business.

And I was just wondering if you could drill into that a little bit more?

How should we think about that growth rate being representative of the omni-channel investments that you have been making, relative to more traditional e-commerce traffic and growth drivers?

And then you also touched upon China eCommerce growth in other regions.

How does your omni-channel capability set you apart from your competitors in these other regions, these international regions?

Thank you.

Matt, I will just start, and I will turn it over to Glenn.

But just as a reminder, on all of our sales in the first quarter including our online sales, and we are really proud of the underlying growth, but it definitely benefited from the calendar shift.

So we have talked quite a bit.

And I said it again, that this first quarter dropped off a small February and added to May.

So all of our sales including online benefited from that, and I will turn it to Glenn.

The only other thing I would add to that Matt, is while I think it is easy to go to the omni-channel number -- I'm sorry, the omni-channel initiative and point to the online number, and there some truth to that.

It is still early days for us, and I am not going to -- probably don't want to have too many baseball analogies today, but it's still early, but there is some contribution.

As Sabrina said, it was calendar shift, probably a little bit of omni-channel.

But the underlying business has been healthy for a long time, and we have been gaining market share online for a number of years.

And that continued in this quarter.

I think when we think about it when-- we are going to have to figure out how to help you and the other people on the phone identify the value of omni-channel.

But one of the big unlocks is obviously, as more and more people experience the brand through online.

And our traffic becomes at some point -- I can see this coming sooner rather than later -- where more traffic begins online than actually go, than starts in the store.

Then with the different components of omni-channel, a big part of this is getting people to experience the brand, but get them into the store.

So that won't show up in the online number, it should show up in the traffic number.

It should show up in the generation of earnings from a four-wall contribution.

So while the early parts of omni-channel are helping a little bit on the online and more to come, the big win that I am waiting for is getting people who are more comfortable starting online, to experience the brand.

Be inspired by what they see, and then get them into the store.

Internationally, if we had what we don't have today, but there is obviously a roadmap we put together, well, when can the North American components of the omni-channel make their way internationally?

Certainly in a market like Japan and China, that would be leading-edge.

I think a lot of the omni-channel work -- and I travel around the world a lot, seems to be coming out of North America, in particularly the United dates.

In Europe, we would like to get it in there.

There are some very good retailers in Europe, and they are very innovative, and I think some of -- they are already advanced in some of these areas, not necessarily in our sector but in some other sectors.

So I think that the sooner we can get some parts of our omni-channel total package into the European business, I think that will help our European brands compete, and also allow them to gain some market share.

And we will go next to Oliver Chen with Citi.

Hi, congratulations on a great quarter and a great year.

Regarding, Glenn, your comments on the customer sounds quite encouraging.

And what gives you that conviction?

I feel like in this conference call season, we have been hearing mixed signals, in terms of caution from other management teams and volatility in the marketplace.

And secondly, could you comment on looking forward for Old Navy?

Some of the comp last year was driven more by units.

And what do you think about going forward, for the opportunity to comp there on unit versus AUR side?

Thank you.

Well, look, we don't have more of a crystal ball than anybody else.

And what I try to quantify on the phone is that the environment is never going to go back to the way was in 2006 and 2007.

At least we don't see that anytime soon.

We wish.

But I did find this first quarter, and we have our own research we do.

We obviously, we talk to customers a lot, we get feedback.

And when you couple that with good macroeconomic tail winds which are starting to develop, whether that is on the job front.

May not satisfy a lot of people, but it is still good to see.

Whether that is in people's wealth that is tied up in their homes or in their 401(k)s, I think all of those things are positive signs.

And so we are certainly not predicting that the consumer sentiment levels that were in place six or seven years ago are going to return anytime soon.

But we look at a number of different metrics, but one that I am particularly -- as I have studied it for a long time and a fan of is the Reuters University of Michigan survey that comes out.

And I think that consumer sentiment has been moving nicely in the right direction for the last 12 months.

Still a long way from its peak, but I think we are comforted by the direction it is taking.

And this -- I think that is good news.

Yes, and on Old Navy piece, Oliver, it is a good point.

Last year when we were lapping 2011's high average unit costs, when the average unit cost came down especially for Old Navy, because we had pulled so many units out in '11, we were putting them back in, in '12.

So a lot of our comp was driven by that re-infusion of units, but really just to get it back to a normalized level.

So I would say at this point going forward, we are sort of at a position where AUC is stable, it is not a big story either up or down.

So we will be managing the business in a more normalized fashion, which is to say we need to drive our comp with some increase in unit sales.

But with the healthiest AURs we can achieve to meet our goal of delivering that comp growth with healthy margins.

Thank you, and good luck.

Thank you.

We will go next to Janet Kloppenburg with JJK Research.

Hi, everybody.

Congratulations on a great quarter, and it looks like it is continuing.

The stores just look terrific right now.

I wanted to ask Sabrina if you could let us know what your AUC benefit might be in the second quarter versus last year?

And Glenn, given your discussion about the brand strength and the sourcing opportunities, I was wondering how you felt about the promotional levels at Gap and Old Navy in the first quarter?

And if we could expect any change there, in light of how you are feeling about the consumer confidence?

Thank you.

Yes, so with regard to AUC, Janet, what we did say was that the first quarter is really the last quarter where we get the tail wind from all of the movements up and then down on average unit costs that happened in '11 and '12.

And from this point forward, the AUC is really sort of a non-issue.

So the delta in AUC in the remaining quarters is not a meaningful change from the prior year.

And then I will just start off on your promotion question, and let Glenn finish.

Certainly, this year, and it has been well documented on all the earnings calls before us, certainly this year versus last year given the weather patterns in February and March, this year was less favorable for retailers overall in general, just given those weather patterns.

So for the quarter, across the board, we were probably more promotional than we were in 2012.

With that said, I think we are very pleased.

And you can see it in our merch margin performance, and our overall performance, we are pleased with how the teams managed those promotions very surgically.

So we were still able to deliver on our goal of getting that comp up with nice margins.

And when we think of the two brands that you mentioned, Janet, at the end of the day, Old Navy is a brand in a value sector.

So I am -- I think that as long as they are being creative and innovative, and in a lot of ways aggressive, that is what Old Navy needs to do, given as we have talked about the investor conference that market share for us in North America is really one of our top priorities.

I don't want excessive promotions at Old Navy.

I don't want ideas tripping over one another, so a consumer gets confused.

But if they come out on big weekends, like we have this weekend, and go out and dominate and show strength and drive incremental traffic into their business and gain market share.

And I think Stefan and his team are doing the right thing.

And as long, for Old Navy, to me, it is always the voice.

It has a personality.

And if they are just going to be 40% off on Memorial Day weekend, that -- I expect more from Old Navy, to really come out and present its story, and what the brand stands for.

So I encourage them to be aggressive.

Because that is what -- that is why it is a member of the portfolio.

Because it is in the value sector, and its aggressiveness is one of its traits.

At Gap, while I completely agree with what Sabrina said in the first quarter, I think that we put some more marketing into that business.

We are feeling better about our product.

We put some money into stores in some of the key cities around the US, in San Francisco, and sorry -- in New York, in Toronto, in Chicago.

So we are actually expecting that as they continue to improve upon their products, their assortment strategy, and the marketing continues to be driven strongly in the back half of the year.

I don't feel good sometimes about the promotional level at Gap.

I mean, that is an iconic brand, and yes, you need to talk about your value proposition.

But that doesn't mean they are going to be void of promotions.

That is just the world in which we operate.

But I think I would expect as long as those three other components I spoke about earlier continue to strengthen and get better, that their need as their brand health and their relevance in the marketplace grows -- and it is growing from the research we have -- that they would have to be less dependent on some of the promotional decisions, when made in the past and fight a better battle.

Thank you.

And we will go next to Adrienne Tennant with Janney Capital Markets.

Hi, everyone.

Let me add my congratulations.

Well done.

Glenn, your -- the unit normalization strategy obviously has been very successful at Old Navy.

I was wondering, what if anything would make you consider possibly building units at the Gap brand?

And then for Sabrina, a clarification question, the $2.52 to $2.60, does that exclude the $0.04 benefit?

And when you said that it comes out of the fourth quarter, is that the $0.08 shift?

Thank you.

So why don't I start with both of them quickly, and then Glenn can follow up.

On the units, just to be clear, our units -- our goal, Adrienne, is, as we are driving comp is to balance units with AUR.

So I will tell you unit sales across the board for Gap Inc.

were up.

So I don't want to leave you with the impression that we are pulling units out of Gap brand, that is not true.

We are actually marching to that same balance.

Okay.

So we are increasing units at Gap Inc.

across the board, and no brand is a stand-out in that.

So everybody is kind of up in managing their AUR.

With regard to the guidance, so the way to think about that is there is $0.04 of tax benefit, $0.02 are in the rate.

And the rate piece is really just a timing difference, because the full year rate is still 39%.

But the $0.02 that came into interest, that is a one-time benefit that does flow through.

But the range is a $0.08 range, and there is a lot of pluses and minuses.

So just as it is legitimate to bring that $0.02 from the interest on tax through, there is other offsetting items happening as well.

And I called out one of them, which is the yen.

Right.

So with the yen moving, I kind of think of them together, like one is going up, and the other one is hurting us.

Right.

We will see the degree to which it does.

Does that answer your question?

That is super helpful, that absolutely answered it.

Thank you very much.

Great.

And we will go next to Ike Boruchow with Sterne Agee

Hi, thanks for taking my question.

Congrats on a great quarter.

I guess, Glenn, a question on the marketing side of the business.

I know you don't give guidance on what you are planning in terms of dollar growth or anything like that.

But just when you look out for the remainder of the year by brand, where do you see the most investment?

And are you doing -- planning on doing new things especially around the holidays?

Well, it is a little early to tell.

We are just finishing up the holiday product storylines, and the assortment strategy from the teams.

But we -- I think Sabrina and I have been very consistent on marketing.

We feel that with the additional marketing we gave and allowed our brands to use in 2012, and mostly at Gap brand, where we put some money out of home, and focused on our top ten DMAs, and we got some benefit from that.

That is why we didn't pull it back in 2013 -- we didn't add to it, but we didn't pull it back.

So we saw some benefit from the Be Bright campaign, and that was resonating with people.

So I think that we have always felt that there is an ample amount of marketing for our brands to differentiate themselves.

Because our storyline has always been that Gap Inc.

is the portfolio owner of six American brands.

And we don't run stores, therefore there is always a need for some marketing, to be able to make sure that people understand what Old Navy and our Gap, and Banana Republic, and our other brands stand for, what differentiates them, how are they going to win?

So the marketing is a key part of that, beyond just what it can do for traffic, as a story.

And I am feeling better about some of the stories coming out from the team.

But the money and the investment, I am actually -- I don't see a need to put much more money into the brands.

Now the brand's presidents want to make their own decisions, and we will guide them, and we will advise them.

But I think they are also content, and have come to a place they realize they have more than enough money.

The challenge from us is, are they putting it to the right channels?

Are they putting it to the right mediums, are we getting into the right mix?

I would like to see us do more and more on the social side.

I think we have done quite a bit.

I would like to see us do more.

And there are certain points that we are bringing forward and some data that we are sharing with them, in order for them to make the right decisions.

But so far, no need for more money.

And we have never taken anything off the table.

If Gap wanted to do anything different for holiday, if all of a sudden television made sense which I'm not saying it does or even contemplating that, as long as it is within the total budget that we have agreed to, and they want to do something else, that is their decision to present to us.

Right now, I don't see much difference from 2013, in terms of the playbook, besides the creative is going to be different, and the story is going to be different.

Yes, and just to be a little helpful, Q1 was up $4 million.

Q2 as Glenn said in spirit, there is no huge changes planned, but we are certainly not planning on bringing it down in Q2.

So directionally, he was talking about Q1 and Q2.

Thanks.

And we will go next to Lorraine Hutchinson with Bank of America.

Thank you.

Good afternoon.

My question is around the operating margin expansion potential for the rest of the year.

What comps do you need to leverage your fixed expenses, and then where do see some of the bigger opportunities for gross margin expansion going forward?

Yes, so on the leverage, Lorraine, because about half of our total expense base is related to stores, and over that half of that is variable to sales.

The way we think about it is we will manage our expenses in order to leverage our expense base.

Because we have that much that is variable, so it is quite natural that we could use the levers to deliver that while still investing in our business.

Which is why we say you should expect in nominal dollars, expenses to increase, if we are increasing revenue.

But we are always watching for that leverage.

So we sort of reverse engineered if you will, to make sure we can deliver that.

And with regard to the margin rate, we -- Glenn talked about the levers that we still have opportunities to, with the great product assortment, with the opportunities that are -- will be coming in the future around seamless inventory, et cetera, we are always looking to improve our profile with regard to regular price selling, the depth of our promotions, the depth of our markdowns.

So that is obviously a very important lever.

And then on the gross margin line, of course, we want to be leveraging our rent and occupancy, which we feel confident we can do on a positive comp.

And we will go next to Jennifer Davis with Lazard Capital Markets.

Hi, good afternoon.

Glenn, I think I am going to take you back to a baseball analogy.

You referred to this a little bit.

I think it was in response to Janet's question.

Where do you stand in terms of putting money back into the stores, and maybe increasing some of the store payroll and the kind of help there?

I think you still maybe have an opportunity there.

The merchandise looks good, but some of the stores maybe aren't running quite up to the level they should be.

And then Sabrina, thanks for the clarification around the calendar shift.

That was really helpful.

Just wondering how we should think about the second quarter and the third quarter?

I know the shift won't be as big, but will you see a little shift between there?

Thanks.

Well, I have been doing this for a long time.

And what I know is that unfortunately on any given day, something can go bump in the night at a store, and the conditions and the standards, the service can be below our expectations.

What I will tell you is that, two things, one we started to put more money back into our business in last year's P&L, as we became a little more comfortable with product, and as the teams decided that there was a service model -- a customer service model opportunity.

What I think they have done a really good job of is, recognizing if you have a fleet of a 1,000 when it comes to Old Navy, or you have a fleet of 700 stores when it comes to Gap, that there are certain stores where you can actually get a return for that investment.

So they have been much more thoughtful on what stores -- where does the investment need to go?

So in the Banana Republic's case, the return is in the fitting room.

And in Old Navy's case, we put more labor in, and that is in replenishment.

In Gap's case, we put more labor into their businesses on the floor, and actually engaging with customers.

So we understand our brands very well.

We know what our customers want, and we know where labor at times needs to go.

Because we have either tested it, or we just understand our business well enough, what kind of return we would get.

I am disappointed, obviously, you are telling me in a backhanded way, as you have been in some stores lately, and liked the product, or didn't like either the conditions of the store or the service level -- and maybe you can tell Katrina where that was, and we are happy to look into it, because we want to run a good business every single day.

And I know we just had our field conference here in San Francisco with all our store managers, and really got them not only motivated and pumped up about the opportunities going forward, but they understand the role they need to play in the business to run great customer service every single day.

Now we track it, just happened to have Board meetings this week, our scores are up again.

We have had good scores, that -- with that said, Jennifer, my theory on retail is you are only as good as your weakest link.

And if we have a single store in the chain that is not running a good business on a given day, that hurts the overall brand.

And I know our field leaders understand that.

So I think the money is there, and maybe that was just poor execution which is not acceptable, from the way we look at our business.

Yes.

And then with regards to Q2 and Q3, our biggest notable shift due to the calendar are absolutely in Q1 and Q4 as we have noted.

I have heard people talk about Q2 and Q3, and we are really not seeing any meaningful impact from the shift in those two quarters.

I think part of the reason may be, that unlike some of our competitors, we have six brands, many of which don't play in back-to-school.

Obviously, Old Navy does, they are the biggest and Gap some too.

But I think with the six brands and the fact that we are also much more geographically dispersed than some of the competitors that are talking about the Q2, Q3 piece, may be the reasons.

So for us, it is Q1 and Q4, and very little in Q2 and Q3.

Great, thanks.

And Glenn, that wasn't a backhanded comment, it was just -- I think that maybe you still have an opportunity to do a little better.

But as you said, with a big store base it is kind of difficult.

Thanks.

And we will go next to Randy Konik with Jefferies & Company.

Hi.

Can you hear me?

We can hear you.

Yes.

Hi.

So the story we have been trying to tell is the of transformation and sustainability.

So when you think about the ability to obviously, comp on top of comp, and the revenue acceleration after the Company has been in kind of a flat revenue environment for about a decade, how do you tell the market out there, how you believe in the sustainability of a -- from a revenue growth perspective, how should we be thinking about that type of theme?

Thanks.

Well, the reason I mentioned it on the opening comments is only because I think that was written about by most people that, that was a metric that analysts and some investors would be looking for coming off an impressive and strong Q1 in 2012.

So the fact that we backed that 4% comp up with a 2% comp, is nothing that we are surprised about.

It is something that we were planning to do, and as Sabrina said in her comments, we are looking to have a business that comps.

As I said at the Investor conference, we are going to gain market share.

And, Randy, that is a short question that could take a long, long time to answer.

And it really adds up to all the different ingredients that I think we put forth.

But what I would say is that in 2010, which was the -- a year that had not the consumer sentiment we are seeing in 2013, but it was coming out of the very difficult 2008, 2009, the business had a very nice comp, good top line, and had record operating margins.

And that was the beginning of what the business -- with the talent we have, the strategies and the hand we have to play, that was really a turning moment for us.

We started feeling the confidence.

And of course, the cotton events of 2011 happened.

We got distracted, and then we had a good year in 2012.

So we look at it and go, okay, well you can explain 2008, 2009.

Most retailers struggled in those two years, that have had a heavy base rooted in the United States or in Canada.

2010 when conditions were slightly better, we did very well.

2011, I just explained, 2012 conditions were more normalized.

We did well.

Q1 2013, conditions are more normalized, we do well.

So I think that we are a team that has been through all of the different tests that you need to put a team through, whether that is macro test, restructuring test, bringing new people into an organization, embracing change, cultural or physical change, as we have gone into China and other markets.

This business and the leadership has proven to be incredibly resilient.

So we are not trying to say that this is any prediction going forward.

But I think 2012, now into '13, as I mentioned in my consumer comments, we feel that the consumer is slightly getting better.

And now it is up to people to look at -- as Jennifer was saying, by going to our stores and seeing the product, that I think the team is starting to put back to back to back performance together with a lot more opportunity to come.

Back to Janet's question on the operating lever and the changes to our operating model, which provide even greater efficiency and value to be unlocked.

So we understand what we have to get done.

It is a very competitive market.

There is a lot of people in our business, but our portfolio strategy that takes us from value to luxury in North America, and our international growth opportunity, I think you put that together, and there is lots more we can do here at Gap Inc.

And we have time for one more question.

We will go to Brian Tunick with JPMorgan.

I will add congrats as well.

Just curious if you hindsighted, or done any survey work, regarding where did you lose your customer to over the last couple of years.

And sort of what are they telling you now, regarding where they are coming from?

And are you measuring both conversion and traffic to try to gauge how you are doing on that trend?

Thanks very much.

Brian, we have more data than you can imagine here.

But it is -- I think the best information we have, is just we talk to existing customers.

We have a very strong existing base, who I think -- what the struggle with them when maybe our business was not as strong as we would like to be, was frequency.

We had them coming in, it was just frequency.

And we have a strong base of lapsed customers, people who don't come in for an extended period of time.

And we know how to speak to them, and obviously get them back engaged, and they still feel very strongly.

This is just at a very high level, but any one of our brands, any lapsed customer felt good about the brand, didn't for a reason find -- didn't have a reason to come in for an extended period of time.

Now we are speaking to them more often in 2012, and continue 2013.

What I would say, is back to the opportunities available to Gap Inc., are the number of new customers we need to get into our business.

And people who maybe have never experienced the brand, maybe they are just coming of that age when it makes sense.

Or we had a period of time where we were not as strong as we should have been, not as relevant a product from a marketing, a store perspective.

And we just skipped a period of time where people were not coming in with the natural curiosity you get from mall shoppers.

So I think that is the work -- I am certainly encouraging our brand presidents is, you have got to strengthen your strength with your loyal customers.

There is an opportunity with lapsed.

I think some work has started on the front.

And I am very engaged with them on those new customers, who we have -- we have more to offer, more to speak to them about.

And when we have focus groups, when we get new customers together, and take them through our business, take them through our product, they get engaged.

I mean, it is the response is definitely there.

They know of the brand, it is just not a brand on their consideration list.

And we need to be on everybody's consideration list.

So I think there is some good work going on that front, but more to come.

I think it is just early days on the new customer front.

That like to thank everyone for joining us on the call today.

And as a reminder, our earnings press release which is available on GapInc.com contains a full recap of our first quarter results, as well as the forward-looking statements included in Sabrina's remarks.

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

Thank you.

Thank you, that does conclude our conference.

You may now disconnect.