蓋璞 (GPS) 2015 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen.

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

At this time, I would like to welcome everyone to the Gap Incorporated first-quarter 2015 conference call.

(Operator Instructions)

I would now like to introduce your host, Jack Calandra, Senior Vice President of Investor Relations.

Good afternoon, everyone.

Welcome to Gap Inc.'s first-quarter 2015 earnings conference call.

Before we begin, 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 or descriptions of measures we are required to reconcile to GAAP financial measures, please refer to today's earnings press release, as well as our most recent annual report on Form 10-K and our subsequent filings with the SEC, all of which are available on gapinc.com.

These forward-looking statements are based on information as of May 21, 2015, and we assume no obligation to publicly update or revise our forward-looking statements.

Joining us on the call today are CEO Art Peck, and Executive Vice President and CFO Sabrina Simmons.

Sabrina will be using slides to supplement her remarks, which you can view by going to the Investor Relations section at gapinc.com.

With that, I'd like to turn the call over to Art.

Thanks, Jack, and good afternoon, everyone.

I am pleased to be here speaking to you now in my second earnings call as CEO.

The most important thing I want to do today is reemphasize our earnings guidance for the year.

You have, I'm sure, our press release in front of you.

You have the details underneath that.

And after I am done, I will hand it over to Sabrina Simmons, who will take you through the specific detail.

And obviously, we will have Q&A at the end of this call.

We will talk about our first-quarter results, and I'll go a little bit deeper into what's been going on over the last three months.

There are three issues that really impacted the first quarter.

Two of those are macro factors, which we have spoken to you about before, in terms of foreign exchange and the West Coast port situation.

Sabrina will spend a little bit more time on that.

I really want to dive in on the underlying results of our three global brands and, specifically, the performance of our women's businesses.

As we have said, and we continue to see, we have had an exceptionally well-performing women's business at Old Navy, which has driven great profitable growth.

Product acceptance at Gap in the women's business has been tough, and we are focused on making it happen.

And at Banana Republic, it's a work in process, and we have work to do there as well.

Let me start first by spending a few minutes on Old Navy.

Obviously, it's a very good story -- a story that we are very pleased with, and a story that we have confidence in that it's going to continue to repeat itself on a going-forward basis.

Three years of excellent performance and, most importantly, underneath the covers, growth that is being driven in a very high-quality way with a very nice margin story underneath it.

Q1 comp was a women's story.

And I am saying that in particular because, as we have struggled with our women's business, in Gap, as an example, Old Navy is an excellent example where we continue to get women's right, season after season.

And we are very pleased with the performance that we are seeing with on-brand, on-trend product in our stores.

I need to point out that this is a combination of factors.

It is clearly a team working well together, led by Stefan, that is delivering this performance.

But it is also underlying process changes that we have made in the way that we are running the Business, and the way that we are bringing product to market that is delivering the consistency that we are seeing.

I have mentioned this before, but I need to mention it again, which is: We are taking these changes, and in some cases largely transplanting them, into our other businesses, and that they are proven inside of Old Navy, and they have been delivering this kind of performance.

Again, we have a strong women's business there, but it's been followed by a pretty strong business inside the rest of the box as well, across men's, kids and baby.

And it's a thing of beauty when Old Navy is firing on all cylinders, and has now for several seasons running.

On the flip side, I continue to be disappointed, but not surprised, by Gap's performance.

We have had a women's business challenge now for several seasons running.

I believe we have diagnosed it correctly, having to do with being off-brand, in some cases off-trend, and I can promise you that the team is all over it.

In the last call that we had, I mentioned the hiring of Wendi Goldman.

Wendi has hit the ground running.

She is a highly collaborative, skilled leader, working with the team.

And I've been really pleased so far the results the whole team is producing, as they have focused on holiday, and obviously on spring.

Jeff really has three priorities right now, and I want to underline and emphasize those to you.

We are in season every day, and we are managing the Business as aggressively as we can to get every penny out of the Business.

In relative terms, kids and baby is performing better, and men's is performing better.

But to be clear, I am not happy and Jeff is not happy with the entire performance of the brand, and we are committed to turning it around.

On top of managing in season, we are obviously working extremely hard to make every improvement that we can to the outlying seasons, including holiday and, most importantly, spring.

On top of that, I said I was impatient.

We are working very hard to change the product processes -- a la what we are doing at Old Navy -- in order to get Gap to a more consistent, on-trend, on-brand footing.

And I have to say, much of the work that the team has done there to realign the team on the aesthetic of the brand is very, very encouraging.

Banana Republic is a mixed bag.

This was Marissa's first collection, showing up later in the quarter.

It has had a couple of very positive impacts in terms of reestablishing some fashion credibility for the brand, and the relevance of the brand.

But we didn't get it 100% right.

And this is not to be excused, but perhaps expected, as you are bringing a new designer and a new leadership team together.

The color palette was pretty stark between black and white; not enough color in print and pattern for the season that we are in.

And we are still working to buy an assortment that is both commercial and fashion-oriented.

Relatively speaking, the men's business is stronger.

And it's not that the women's business is weak, but we have not hit the stride, nor delivered the commercial results; while at the same time we have established some fashion credibility.

And that is our job, and we are focused on making it happen.

In a moment, I will turn it over to Sabrina.

What I wanted to do is offer a few comments in advance about how Sabrina and I are working together, and the commitment that we very much share together.

Obviously, a big part of our story over the last several years has been the fact that we are committed to a responsible capital structure and, as this Company continues to generate a significant amount of cash, we are committed to distributing net excess cash to the benefit of our shareholders.

It's important for me to emphasize that Sabrina and I are highly aligned on continuing that going forward, while at the same time, responsibly reinvesting in the Business.

Sabrina, let me pass it to you.

Thank you, Art.

Good afternoon, everyone.

As anticipated, our first-quarter results were impacted by foreign exchange headwinds and delayed receipts due to the West Coast port issues.

Despite these dynamics, we're pleased that Old Navy delivered another strong quarter, on top of three years of growth.

As Art mentioned, we are focused on taking the steps necessary to drive improvements and greater consistency in our other brands, while continuing to make progress on our long-term objectives.

Operating income for the first quarter was $386 million versus $443 million last year.

Net earnings were $239 million.

On a reported basis, earnings per share were $0.56, down about 3% versus $0.58 last year.

It's important to note that our reported earnings per share were negatively impacted by foreign exchange.

We estimate that foreign exchange reduced our reported earnings-per-share growth rate by about 3 percentage points.

Sales for the first quarter were also impacted by foreign exchange and the port issues.

As reported, first-quarter sales were $3.7 billion, down 3% versus last year.

The translation of foreign revenues into dollars negatively impacted our reported net sales by about $90 million in the first quarter.

On a constant-currency basis, net sales were down about 1%.

Regarding the port impact, there is no meaningful change to our first-half estimate of $0.13.

As a reminder, first-quarter sales were impacted by having fewer units available for sale.

We expect that second quarter will be impacted by late units that will likely be sold at lower margins.

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

Moving to gross margin, first-quarter gross margin was down 100 basis points to 37.8%.

Merchandise margins were about flat, driven by strong performance at Old Navy, offset by the impact of foreign exchange, as well as disappointing performance at Gap Brand.

Rent and occupancy deleveraged 100 basis points.

In the face of challenging sales performance, we managed SG&A tightly.

First-quarter total operating expenses were $996 million, down $27 million from the prior year, driven by foreign exchange favorability.

Marketing expenses were down about $7 million versus last year to $136 million.

As a percent of sales, total operating expenses were 27.2%, and deleveraged about 10 basis points versus last year.

As a reminder, in Q2 we will lap last year's gain on sale of nearly $40 million.

Therefore, we expect greater deleverage in Q2 versus Q1.

Regarding the balance sheet and cash flow, inventory dollars per store were up about 4% at the end of the first quarter.

As anticipated, delayed receipts due to the West Coast port situation resulted in higher in-transit inventory levels at the end of the first quarter.

We expect year-over-year inventory dollars per store at the end of the second quarter to be up slightly versus last year, as we focus on selling through these late receipts, while trying to maximize margin.

As a reminder, last year's inventory per store was up only 2% in Q2 versus up 7% at the end of Q1.

For the quarter, free cash flow was an inflow of $61 million.

Underscoring our commitment to distribute excess cash to shareholders, we distributed more than 5 times our free cash flow, or $329 million this quarter.

This includes $230 million to repurchase 5.6 million shares, resulting in a quarter-end share count of 419 million.

Regarding capital expenditures and store count, first-quarter capital expenditures were $150 million.

We opened 29 Company-operated stores on a net basis, and ended the quarter with 3,309 stores.

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

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

Our first-quarter performance was broadly in line with our expectations at the time we provided our full-year guidance in February.

Therefore, we are reaffirming our full-year earnings-per-share guidance range of $2.75 to $2.80.

For the full year, all other guidance metrics remain substantially unchanged.

In closing, as we enter the second quarter we will continue to focus on levers that we can control, while we work to deliver compelling product assortments across all of our brands.

Thank you.

And now I'll turn it back over to Jack.

That concludes our prepared remarks.

We will now open up the call to questions.

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

Randy Konik with Jefferies.

Sorry about that.

Phone issues here.

Hey.

How are you?

Good.

Art, first on the -- let's dive right into right on the Gap.

You talked a little bit about the relative better performance around kid and baby and men's.

Relative to the traffic of what you are seeing at Banana and the mall, is it more -- is it truly a traffic issue conversion issue?

Is the mom going in there for the baby but just saying that these clothes -- I can't buy this?

Just trying to get a perspective on what is truly the problem there.

And then as a relates to your perspective on the women's side, is it -- it sounds like it is a combination of inconsistent fit, lack of color, bad marketing -- or not the best marketing, what have you.

Just want to get your perspective on what -- which of these things are most important to improve, which can be turned the fastest, et cetera.

Thanks.

Randy, it's the same thing.

I think we've been, and I've been, pretty consistent in talking about, which is we know we have problems in the women's business.

We've diagnosed it.

We've diagnosed it because you can go in there and look at it.

I spend time in stores.

I talk to customers.

I watch what customers buy.

We look at our product's acceptance and the issues are clear and have been clear for several seasons.

And so -- and it is a combination of all of the above, which is we've got -- we are off-trend and, in some cases, way off the brand.

We have some quality and fit issues where we made some choices.

And the issue is that when the women's business -- which is why I am focused on the women's business -- when the women's business isn't working, it does, in a brand like Gap, which is obviously duel gender and then whole family, have a negative halo on the rest of the box.

But we are actually getting very good customer feedback on our kids and baby business.

The men's business continues to be relatively strong.

And so it's why when I have been working with Jeff and the team, it's been prioritize the women's business because as it halos negatively when it's not working, it has the same halo affect positively when it is working.

And I'm actually -- I'm pretty encouraged by what I see going forward.

I can even look at the holiday assortment, which is largely landed now, and some of the sort of obvious mistakes that we've made, we have -- they are gone from the line.

We've actually taken the step of canceling some styles that we had that we knew were just not salable, which is an appropriate thing to do as well, which we have been able to do.

So from that standpoint, again, same thing I'm saying before, team heads down working on the women's assortment and getting it back on track as much as we can do in holiday, acknowledging it was mostly bought, and then spring being a no excuses moment.

Thanks.

John Morris with BMO Capital Markets.

Thanks.

Good afternoon, everybody.

Art, maybe if you could give us a little bit about your philosophy on handling marketing and marketing spend go forward.

I am sure we will hear from Sabrina, as well, in terms of the thoughts about the numbers.

But I wanted to get a little bit on the philosophy.

We saw that you pulled back a little bit in the quarter and what can we expect and where are you thinking about allocating it by brand and your philosophy around that?

Thanks.

The simplest philosophical statement that is easiest to make is that when you are not proud of your product, you are not going to be out there putting a lot of marketing behind the business.

And that is exactly the strategy that I followed back in 2011 when we looked forward down the pipeline, didn't feel good about the product and, consequently, pulled back on a lot of the working media spend that we had in place.

And we are doing some of that now as well.

The other side of that is I am feeling like we are really getting our returns in the marketing spend that we have at Old Navy.

And when I can see the returns and it can help drive the business, I'm happy to put money into the business as well.

So it's really about placing smart bets, not just sticking with a marketing plan or anything like that.

So expect us to be tight and, as the product it's better, expect us to then start putting a little bit of pressure on the business.

But you correctly have seen that we have pulled back and we will continue to do that until we feel like there is an opportunity to really tell a story.

And the second issue is, and this is a topic broadly separate from the current performance of the business that both Sabrina and I are very focused on right now, we have over a long period of time generally spent more than many of the competitors out there in terms of marketing.

And I think we should be getting more out of our marketing dollar than we are at the end of the day.

Sabrina, do you want to add anything to that?

Yes.

I was just going to add to be helpful, which underscores what Art said, is in the quarter, as you might imagine with Old Navy positive comping, they are not down at all in marketing dollars.

In fact, they are up.

And the improvement comes a little bit from everywhere else where we are not as happy.

And it also includes, by the way, I should say, Piperlime because we closed that in the quarter.

And so we are not marketing behind that.

And then with regard to the second quarter, I would just say there is not going to be any radical change because it's likely to follow the same pattern as Q1.

So I would look at some thing starting as -- last year is a good starting point to the second quarter.

Okay thanks.

Good luck.

Thanks.

Oliver Chen with Cowen and Company.

Hi.

Thank you.

I have a broader question about how you are feeling about supply chain and test, read and react and manage inventories and how this will work in terms of your strategic planning.

And then I do think we are observing some newness on the trend front in the marketplace, from our perspective.

I'm just wondering what vehicles might be best for you to try to capitalize upon that newness factor that seems to be happening in some bottoms and tops.

So the story on supply chain is, as we have been telling it, that we are continuing to push on it on a number of the elements, on platform fabric, which enables us to get back into season very quickly on some of the test and respond that we have been doing.

Old Navy is furthest ahead and realizing this.

With the changes that have taken place, obviously, and the challenges of the business of Gap, changes in leadership, challenges in the business -- those two businesses lag.

Banana is probably in the middle and Gap is furthest behind.

But I can say, quite confidently, is that as we have implemented it, it's very clear that it's having a positive impact and it is the right thing to do.

And then the question really is scaling it and continuing to scale it as fast as we can.

And so -- and we are using this in some cases to do exactly what you talked about with respect to a trend out there that we see or something like that.

We will put a set of silhouettes in in bottoms and we will see which sells and allows us to go cut more aggressively and respond more quickly into the silhouettes that are selling right now.

And obviously in denim, as an example, there's a lot of variation out there in terms of rise, in terms of leg silhouette and the novelty.

And we're being more responsive there.

Knits is an easy one, where we have also used that and, particularly inside of Old Navy, to be more responsive to where the knits business has really shown some real strength and put some volume behind it.

So it's a clear capability.

As I've said pretty publicly, we are in a business that we guess a lot.

And anything that we can do to minimize the guesses and gets better and inform it with data has a real positive impact on the business.

Okay, Art.

And just your -- just for expectations, it's more about spring versus holiday, but you have made some tweaks for holiday.

I just wanted to understand how we should think about the catalyst and timing.

So in Gap Brand specifically you mean?

Yes.

I'm going to stick to my same story there, which is that I don't want to make any promises about holiday, because, as the team got in place, holiday had a pretty good head of steam behind it.

And so much of it was developed.

What I can say is that the team didn't not do anything.

And they've put their shoulder against it and made some changes there.

I am certainly hoping it will be better.

And from what I have seen, I have seen some encouraging elements of the assortment that I think are much better placed.

But I'm really putting my big expectation on spring.

Thank you.

Best regards.

Sure.

Ladies and gentlemen, as a reminder, please limit your questions to one per participant.

Matthew Boss with JPMorgan.

Hi.

Good afternoon.

So expense control remains pretty impressive over at this year and the last couple, actually.

What type of flexibility do you think remains on a go-forward basis?

And particularly, if a topline turn were not to materialize at the end of this year, or even in the spring, what room do you have to continue to cut some expenses?

A big part of our expense base is related to our stores.

And that varies -- in large part about half of that varies with sales.

So we do have the benefit that if sales do not -- are not realized to the extent we would like them to be, we have the natural variable component that comes down.

So that's one piece that will always be in the works.

With regard to how we deliver the expense savings this quarter to help you think about how we would do it in future quarters, a chunk of it came from foreign exchange.

So we call that out.

And so we benefited, probably between the translation and balance sheet remeasurement, about $30 million of benefit.

Even after that though, expenses were pretty close to last year.

So very tight.

And that comes primarily from this variable component I talked about as well as we brought that marketing down a little bit by $7 million.

And so we would continue to use those levers that are variable or discretionary, like marketing.

Q2, I just want to call out again, is a very different dynamic because we leveraged last year in Q2 by 190 basis points.

So just from a sheer optic perspective, that includes the gain on sale of $40 million last year.

So we are going to be lapping that and then we layer on really kicking in in June the wage increase.

So the deleverage we would expect to be higher in Q2 just because of what we are anniversarying such high leverage.

But we will, behind the scenes, continue to work all the levers we have at our disposal to manage our expenses very tightly, especially if we are not realizing the sales we would expect.

Great.

And then just a quick follow-up, online posted the first year-over-year contraction that I can remember maybe ever.

Can you just talk about initiatives in place to stabilize this channel, as well?

Yes online number really was driven and impacted by the ports as well.

So number one is sort of at a high level.

It's important to remember that they too were impacted by that.

The second piece is the Piperlime closer.

So again, we wound down and actually finished closing Piperlime in the first quarter.

So that's going to be another chunk of it.

And then you just have the effect of Gap Brand product acceptance being fairly weak.

So you put those three together and you come up with we are not happy with that number at all.

But we would expect it to improve once we are out of this port situation, certainly, and get back to a more normalized level.

Okay great.

That's really helpful.

Matt McClintock from Barclays.

Yes, good afternoon, everybody.

Art, I was wondering if we could focus on Old Navy for a bit.

Three consecutive years of solid comp store sales performance and it would appear that that performance should just be now gaining steam from some of your supply chain initiatives.

Can you talk about the evolution of Old Navy's comps, of the performance there from the beginning?

Three years ago we put up a solid 6% increase to the most recent result.

And how should we think about this evolution as those supply chain improvements continue to accelerate your ability to deliver fresh fashion to that business?

Thanks.

I'm glad you are seeing that.

And you can probably read the articles in the newspaper earlier this week, as well.

There is some information in there.

I think, and I hope, what you are seeing and what you are believing is that you put that much consistency in place, three years, multiple quarters back-to-back, and there's a reason behind that.

And there is a reason behind that.

And it is -- it starts with, obviously, Stefan and his team, which is a really good team, working well together.

But the much more important thing behind the scenes is that team living inside of a very disciplined process and a set of process changes that is allowing for the consistency.

Again, I say this often publicly that it's relatively easy to have a great quarter.

What is superlatively hard in this industry is to put quarter after quarter together and then year after year.

So we have a lot of confidence there in the processes and capabilities that we have built.

It starts with what we think is a really great process right at the beginning, which filters trend really systematically across a wide variety of sources, filters trend down to the right ones that we feel are brand right and appropriately commercial for Old Navy.

And it has allowed us to be in trends that are happening at the same time in the designer and the premium contemporary space.

It's allowed us to be into those trends in Old Navy almost in a simultaneous way, which really is the way the world is working right now.

And so that ability to be right and to respond very quickly is powerful.

And then if you just go down into the system, there's a really -- I think a really disciplined and structured management of the assortment that we are running as well right now, which allows us to maintain the proper amount of newness entering the portfolio, but also have a super solid set of styles that are proven that we can invest in over several seasons to help us really drive the commercial plan of the Business.

I guess the way I think about it is that a healthy business is a business that is gaining market share.

And Old Navy has now demonstrated its ability to hunt and win at market share pretty consistently for a number of quarters running.

So I won't say that this is going to be perfect every time, because it's tough in this industry with fashion.

But I do have a great deal of confidence in the system and process that we have built there.

And it's obviously why we are working very aggressively with Jeff and his team and Andi and her team to almost do turnkey installation of some of these components into the other businesses as well.

And we will see the results there on a going forward basis.

But I have been really pleased with what we see with Old Navy and really confident with what we see going forward.

Thanks a lot, Art.

Yes.

Susan Anderson with FBR Capital Markets.

Hi.

Good evening.

Thanks for taking my question.

I wanted to ask just about expectations for gross margin as we go throughout the year.

I assume in second quarter it should be worse because of the port situation.

But then should we expect it to inflect positively in the back half, or should we expect continued SG&A to help to offset that to get to your EBIT margin guidance?

Thanks.

That is a tough question, because we do not guide to gross margin, Susan.

But to try and be helpful, we do -- we have given a perspective on operating margin.

The gross margin, what I will tell you, just to keep in mind, you are absolutely correct with your view that there is going to be pressure that we expect in the second quarter because of the port, for sure.

As reminder, we are also dealing with this year headwinds within the gross margin line due to foreign exchange.

So that is just part of what we laid out at the early part of the year for everyone to understand, because we have that very large Japan and Canada business.

Then other that, I will tell you once we are past the first half port impact, of course we will be heads down on trying to deliver the healthiest margin we can.

And we will ultimately continue to use all of our levers to try and put up the best value that we can every quarter.

So we will see how that works out.

Got it.

That's helpful.

Thank you.

Kimberly Greenberger with Morgan Stanley.

Great.

Thank you so much.

Art, you talked about some of the improvements in changes in processes at Old Navy that have been implemented there over the last couple of years and that you felt like those processes and that those improvements could be transported, I think, to Gap and Banana.

Could you just talk to us about what -- just help us understand exactly what those process improvements are, if the transportation process from one division to the other has already started to happen, or the knowledge sharing has already started to happen.

When do you think we might see the early results of that in terms of the merchandise in-store?

Thanks so much.

Again, I reiterate -- let me reiterate what I said in my comments.

The three lanes of work that Jeff and his team are focused on right now, specifically in Gap.

Obviously you have to run the business aggressively in season and we are doing that.

The team is heads down on the business on a global basis.

The second issue is fix as much of the product as we can that is in the pipeline and deliver spring women's product in a brand appropriate, trend appropriate way.

And then the third is rebuilding the product processes.

So there are a lot of plates spinning right now inside of Jeff's world.

But he and I both feel very strongly that we can't wait.

So we're working these things simultaneously.

If you think about some of the key elements of the process, one is very simply the length of the pipeline and Old Navy has been running on a shorter pipeline for a while.

And Gap is developing on that pipeline now as we speak.

And then there is the trend process, the assortment architecture, the supply chain capabilities, a number of other things as well, which we are layering in.

Quite honestly, Jeff and I are sitting here saying how much can we throw at the organization and how fast can we push?

But we are pushing pretty hard and pretty fast.

Spring will come to market with a shorter pipeline.

But it's going to be a hybrid, really, of the way they've traditionally brought it to market and the new process that we are building with them to get more and more up to speed on the new platform as we go through product development for 2016 and the outlying seasons.

I can't tell you exactly when there is going to be a lights-on moment of this revealing itself because it was at Old Navy and it is in both Banana and Gap more of a progressive rebuild.

But some of the key elements are ready in place right now.

Lindsay Drucker Mann with Goldman Sachs.

Thanks.

Hi, everyone.

I wanted to ask about Old Navy and, given the brand success, whether you think there is opportunity to take a little bit of AUR?

And how you are thinking about AUR generally in light of the lower AUC environment for the back half.

Thanks.

To me, AUR is one of those things that if you have confidence, you can achieve it, it's a thing of beauty.

And our issue with AUR as a Company has been our inconsistency in our ability to achieve AUR.

Again, inside of Stefan's business there has been an opportunity that they have had and they have demonstrated their ability to -- mostly out of mix, really not out of make at the end of the day.

One of the things that is really cool about what is going on at Old Navy is that they are able in many cases to achieve cost reductions, an elevated sense of quality and a mix up all at the same time.

It is from AUR.

Now it is in selective categories.

So this is one where Sabrina and I are absolutely in lock step, which is to put AUR and look for AUR on the basis of mix and track record.

Because it's proved to be way too elusive at times, not just for us, but for other people in this industry.

And the other side of AUR, having nothing to do really with the make of the product, or AUC, is just getting off of the depth of the promotions that we have had in some parts of the Company.

And frankly, in my view, that's probably a much bigger AUR opportunity in the near to medium term than any fundamental changes in product mix or product make.

We have been very heavily discounted, as you know.

And in some cases over-bought in areas where the product is not registering.

And that's a tough spot to be.

So a second part of Gap is to really make sure that we are buying holiday and spring in exactly the right way.

And again, I've said publicly that I have a pretty strong bias towards always modestly under buying a season and looking for upside in AUR versus trying to force a lot of units through the system.

Great.

And if I could just ask one follow-up.

Art, when we met with you last you had talked about thinking about some different ways you might conceptualize the store format and different things that you were thinking about.

Have any of those experimental or newer evolved store formats come into clearer focus?

Thank you.

We are still working on it on the inside.

Old Navy has something that they will be testing.

I'm not quite sure of the timing yet, but certainly within the course of this calendar year.

And then I am focused on our international expansion, as well, and in particular for both Old Navy and Gap.

The store size is a big opportunity for us in terms of opening up smaller, more productive real estate spaces where we otherwise wouldn't actually necessarily be able to open a store.

So it is -- I'm not ready to make a pronouncement on this one.

But it hasn't lost any of its importance and it certainly is being backed across the Company with a high degree of urgency.

Thank you.

Adrianne Neve with Janney Capital Markets.

Good afternoon.

Quick question on the inventory.

I know that Old Navy has been in a position of chase throughout fourth quarter and into the first quarter.

You were able to cut some inventories at Gap going into late summer -- late spring/summer.

So I'm wondering, are you comfortable with your inventory levels now?

And then really quickly, if you could just talk about AUC opportunity in the back half.

Thank you very much.

Sure.

So the inventory increase, Adrianne, is really mostly due to the [intransigent] issue related to the port.

We told you guys we wanted to goal ourselves at the beginning of the year, excluding the port, something like slightly down to flattish.

And I would say we are pretty much there excluding this port issue that puts us up four.

And then you see that we try and get back with the guidance in Q2 of getting back to tighter inventories, slightly up.

And the reason we are giving ourselves a little bit of wiggle room is with those late inventories coming in, we don't want to do anything unnatural if goods aren't really liable to just force the sell-through to get to an EOQ.

But it is still fairly tight when you think about it to be slightly up when last year we are lapping only an up two.

So overall, I would say we are comfortable with our inventory levels and will continue to manage them quite tightly.

And your second question was --

On AUC opportunity with cotton deflation.

Oh right.

Yes.

So that opportunity really begins with summer flows because we told you we bought our -- when we bought our spring flows, cotton really wasn't down yet.

And so, yes, we hope to capture -- and we feel confident that in the second half we should get some tailwind.

The magnitude of that we have also talked about isn't -- it's a low single-digit, certainly.

Because the simple math that we try to help you all with to be illustrative is that if cotton prices were down 20% when we placed those orders, broadly you would expect, with nothing else changing, you would expect AUC down about 2%.

But of course there is always some mix and a little bit of reinvestment here and there.

But that is sort of directionally what we are trying to capture in the back half.

Okay great.

Thank you so much.

Lorraine Hutchinson with Bank of America Merrill Lynch.

Thank you.

Good afternoon.

Art, could you share your updated thoughts on square footage and points of distribution for both the Gap and Banana brands?

Yes.

I mean it's a pretty simple conversation, I would say right now, which is that we are always looking at real estate opportunities, whether it's a store that we should be in, because the center has -- is no longer relevant, whether its an opportunity to down size or reposition.

And so that's part of the normal ongoing part of how we (inaudible - background noise).

And that's really the work that the team is doing all the time.

And it's obviously here in North America where we have the most mature business.

But we're obviously doing that all around the world across all of our fleets.

So not really ready to say anything more about it right now in any form other than it is part of how we view running the business in a responsible way.

Sabrina, I don't know if you want to add anything more to that.

That's right.

I mean reviews on the fleet are done on an ongoing basis.

And obviously we look even more deeply when brands are underperforming.

Overall, historically Banana Republic has had very high returns and they have a pretty tight fleet size.

So work underway more to come, I would say.

But yes, it's always on our radar and its an ongoing initiative.

Thank you.

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

As a reminder, the press release, which is available on www.gapinc.com, contains a full recap of our first quarter results as well as the forward-looking guidance included in our prepared remarks.

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

Thank you.

Ladies and gentlemen this does conclude today's conference.

We thank you for your participation.