蓋璞 (GPS) 2016 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen.

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

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

third-quarter 2016 conference call.

(Operator Instructions)

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

Please go ahead, Sir.

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 and descriptions of non-GAAP financial measures, as noted on page 2 of the slides supplementing Sabrina's remarks, 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 November 17, 2016, and we assume no obligation to publicly update or revise our forward-looking statements.

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

As I mentioned, Sabrina will be using slides to supplement her remarks which you can view by going to the Investors Section at gapinc.com.

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

Thanks, Jack, and good afternoon to everyone.

I am going to talk, as I have in all of the calls that we have had, really about both the long game and the short game.

And let me start continuing to address the strategy and many of the things that I've been talking to you about and give you an update on where we are there, but then also obviously, a deeper dive into Q3 and the prospects that I see as we look into this holiday period and Q4.

We are, I would say, well into transforming and rebuilding parts of this Company, starting with our product model.

And I've talked to you about the work that we've been doing to enhance our responsiveness across all of our brands and in key categories, to pivot towards a much more continuous and demand based buying process, to test our products in advance of the buys that we are placing, to go into season open, et cetera.

And I continue to be pleased with the progress that we are making, but also acknowledging the fact that this is a journey and there remains significant work in front of us.

First and foremost, we need to win on product.

And as I look into Q4, I am feeling very good about the product that we have in our stores across all of our brands.

Obviously, the consumers will tell us how well we are doing and how well we did with the products after we hindsight the season; but if I look across all of the businesses, I feel like we are in the best place that we have been now for several seasons where we are lined up against trend, where we have consistent quality appropriate to the brands, where we've gotten our fit dialed in the point where it is consistent and where each brand is showing up expressing the DNA and the fingerprints of the brand.

Second thing I'd like to talk about is the fact that we are heads down focused on ringing every penny out of places where we have scale advantage.

And that is obviously both on the product side of the equation but on the several billion dollars elsewhere in the Company where we purchase a wide variety of things.

And that is work that is not done, but it is work that is significantly underway, and again, work that I think has very significant pay off over the medium-term.

The third thing that I've spent time talking about is innovation in products.

And again, we're in the early days of innovation in the ready-to-wear space, but already there is good evidence of how we can cross ref innovation from the active side of the business into the ready-to-wear business and create meaningful benefits and have consumers connect with those product benefits in our ready-to-wear product.

A good example of this is the Sculptek product that Athleta introduced a few months ago.

Performing very well in Athletic stores as a compression shaping product, it is also a proprietary fiber and now we're moving to pull that into other bottoms fabrications, including denim and tool fabrications.

And the properties that, that allows us to deliver in what is a traditional denim fabrication were actually quite extraordinary.

And so as we get this up and running, I am continuing to be very encouraged by how our consumers are responding to it, how we are delivering things beyond just trend to make the benefits of that product very meaningful to them.

Demand based buying is a critical piece.

And again, to refresh your perspective, we and many others have traditionally bought the year one season on a grand reveal at a time.

And that means making large commitments well in advance of when the product is going to be in the store and well in advance of knowing what the consumer really wants.

So as we have been building the responsive supply chain capabilities, we have also been reengineering the front end of the business so that we can buy on a much more continuous basis, in many cases, every month versus on a quarterly basis.

And again, this bring several benefits.

We remain open as we get closer to the season and can pivot the buy to the most meaningful trends and fabrications, but also we are delivering newness constantly into our stores, which we know that our customers respond to.

Outside of the product initiatives, we've also talked about CRM and about the customer and about data and about personalization and about technology.

And we are not letting up on the throttle as we go after those areas as well.

And you may have noted that in the last few months I created a new role in the Company led by a chief customer officer who also has strategy.

And that's really focused on bringing together every aspect of the customer across data, consumer insights, digital touch points, and in-store experiences to create a holistic 360 view of the customer from which we can deliver meaningful benefits to that customer whether they're benefits around loyalty, around personalization, around an in-store experience, a digital experience.

Mobile obviously remains incredibly important, and we continue to see customers move from a desktop or a laptop experience to, not just doing business on their mobile device, but really engaging the brand on their mobile device.

As a consequence, we continue to put aggressive effort against the mobile space.

Some of it is just the basics, but really important basics, like continuing to improve the site speed, how fast our pages load, allowing the mobile site to process a variety of forms of rich content that the consumer increasingly expects to have.

We see mobile as fundamentally where our consumer starts and oftentimes ends their journey, and we need to make sure that we have a mobile experience that is commensurate with every other quality touch point that we have with our brands.

Let me move to China for a second because it's fresh on my mind as I came back from a trip there just a week ago.

I am very bullish on the long-term opportunity in China and while I will acknowledge that the fact that the economy has cooled somewhat and the consumer is a little more cautious there, this probably impacted everybody's business, it has not impacted my enthusiasm for the long-term potential in that market.

We executed a strategy in Old Navy a couple of years ago where we put in place a number of stores across different types of locations, different stores sizes, and we've been working that footprint now for the last several months in order to refine the four wall model.

Secondly, obviously Gap was the business that we planted there first, both in the specialty stores and the Gap factory stores and we continue to see that the customer resonates to that brand and wants to participate in that brand.

And third, the Chinese consumer is fundamentally an omni-channel consumer and I remain very enthusiastic around an online business that is a significant penetration into the retail business and has very attractive economics.

A moment on Q3.

And obviously, Sabrina will take you deeper into the numbers.

First of all, I would say the retail environment in the apparel environment continues to be challenging.

Traffic remains challenging, and as a planning assumption, we believe that will carry forward as well.

We feel that it's appropriate to plan for that.

Obviously, we're doing work to try to beat that trend, but we understand the fact that traffic is likely to continue to be challenging as we look forward.

Given that, I'm actually pretty pleased with Q3 because I see positive momentum even against the backdrop of the Fishkill fire.

And I won't go into the details of Fishkill.

I will say, just as a call-out that I felt like our logistics team in this Company did an extraordinary job of not missing a beat from the standpoint of rewiring our logistics network with our facility in the middle of our country and our facility on the west coast and continuing to keep supply going into our stores on a very cost-efficient fashion.

A quick perspective on Q4.

I believe that I said before that we are well set up from the standpoint of the product and the assortment.

Just as a sidebar again, we continue to move the needle in terms of customer reported experience with fit and quality, which had been very intentional initiatives.

I believe we've taken another step forward in the back half of the year and into Q4 on both of these dimensions.

We are also putting marketing into the business in a way that we haven't over the last couple of years.

With marketing both in BR and in Gap, including TV for Gap, and I'm excited because now is a time when we need to start filling the funnel with lapsed customers and new customers in order to buck the negative traffic trend.

And while I've mentioned BR and Gap in terms of marketing, of course, Old Navy is lined up, as they always are in Q4, with a strong marketing program including the $100,000 a day giveaway for eight days.

So brand by brand, just a few comments.

With Gap, right direction, continuing to show stronger women's performance that I like to call out because the core of that business obviously needs to be a strong women's business.

In the kids assortment, we have a significant expression of licensed product that I'm very excited about.

We've not done a large licensing business and particularly in Q4, we feel that has a lot of relevance.

Old Navy, I think the numbers frankly speak for themselves.

An excellent Q3, an exciting holiday campaign, strong marketing.

I think if you walk into an Old Navy store right now and I've spent a lot of time in those stores all around the country and all around the world, you will see incredible clarity of product message, you will see clear category presentations that are super easy to shop, that's the feedback that we get from our customer.

You know the work that's been going on in Banana on quality and on aesthetic.

Customer feedback is that both are significantly moving in the right direction.

We have a holiday campaign including a catalog which we have not done for years.

It is focused on reaching lapsed customers and new customers and we believe we are set up to continue the improvement of the business there that we are seeing.

Athleta, I have nothing but good things to say, quite honestly.

Positioned obviously against a very strong trend that continues to have legs underneath it, and again, Athleta is an active business, Athleta is also a lifestyle business and that is really the core of Athleta's positioning, that confluence of active and lifestyle which their customers very much respond to.

I haven't spoken about marketing in Athleta.

We have a very connected customer there.

The holiday campaign, Share Your Light, is a campaign that is focused on strong community engagement, which is really a place of strength for them.

I expect Athleta to carry their momentum into Q4.

I expect Athleta to continue to perform as we get into next year as well.

Again, that confluence of lifestyle and performance is powerful.

Before I close, I'd like to acknowledge the announcement that we made a couple of weeks ago about Sabrina Simmons leaving the Company and then just a few days ago about Teri List-Stoll joining as CFO.

First on Teri, I've spent quite a bit of time getting to know her, time in stores, time with product, time across a variety of places in the business.

And I am really excited about her joining the team and the perspective that she brings from her experience.

You'll obviously get more time to get to know her.

Some of you may know her already, but I'm very excited about having her on the team and looking forward to her joining in January.

Let me turn to Sabrina.

She will be missed.

I am sure missed by you and most certainly missed by me and the team here.

She's been an incredible partner to me.

In her nine years as CFO, she has obviously been very passionate about our capital structure, about our investment thesis and just an incredible contributor to the Company and in our relationships with the investment community.

In 15 years at the Company, she has done nothing but perform in an exemplary fashion in every role, and so, I will miss her.

I want to thank her.

I'm very appreciative that she will be here until the end of the fiscal year to facilitate a very orderly and structured transition.

And with that, Sabrina, let me turn it over to you.

Thanks so much for your generous comments, Art.

It's been a great 15 year run and a true privilege to serve the Company and our shareholders.

Now, moving onto third-quarter performance.

Sales totaled $3.8 billion down 2% versus last year.

Comp sales were down 3%.

We were pleased that third-quarter gross margin was up 200 basis points over last year, largely driven by Old Navy.

Merchandise margins expanded 220 basis points and rent and occupancy deleveraged 20 basis points.

Moving to expenses.

Third-quarter total operating expenses were up $78 million to $1.1 billion, including about $35 million related to restructuring charges.

Marketing expenses were up $6 million to $148 million.

Regarding taxes, our reported effective tax rate was 45.2%.

The higher rate was driven by the impact from our restructuring actions, primarily in Japan.

Our adjusted effective tax rate was about 5 percentage points lower.

Turning to earnings, on a reported basis, earnings per share were $0.51.

The non-tax related restructuring costs were about $30 million in the quarter.

This brings our year-to-date non-tax-related restructuring costs to about $180 million.

Excluding the tax and non-tax impact of restructuring, our adjusted earnings per share were $0.60.

Regarding the balance sheet and cash flow, we ended the third quarter with inventory down 4% year over year.

We expect total inventory dollars at the end of the fourth quarter to be down low-single-digits year over year.

Our year-to-date free cash flow was an inflow of over $415 million.

Regarding capital expenditures and square footage, year-to-date capital expenditures were $383 million versus $505 million last year.

Square footage was down 2% compared with last year.

With regard to our outlook for the remainder of the year, we are reaffirming our full-year adjusted earnings per share guidance range of $1.87 to $1.92 excluding restructuring costs.

A few things to note about the assumptions around our guidance.

First, for published reports, industry traffic has decelerated November month-to-date.

Second, as Art mentioned, given that challenging traffic trends have continued, we are investing meaningfully in marketing across our portfolio brands during the holiday season.

We are not necessarily expecting an immediate payback from these investments, but consider them to be important for the longer term health of the business.

Additionally, we are lapping bonus reversals last year which are also a headwind to Q4 expense.

Therefore, we expect SG&A to deleverage in the fourth quarter and for the full year.

Third, we expect rent and occupancy to be more pressured in the fourth quarter due to pre-opening costs associated with our Times Square flagship locations for both Gap and Old Navy, scheduled to open in the back half of 2017.

Given all of these factors, we continue to feel our guidance represents a prudent range.

Regarding other guidance metrics, we expect the negative impact from the fire at our distribution center to be just over 1 comp point in the fourth quarter.

Similar to Q3, the impact will be highest at Gap brand and lowest at Old Navy.

Regarding square footage, we now expect to end the year down 3%, a reduction from our earlier guidance of down 2% driven by additional Gap store closures.

Regarding our restructuring costs, we now estimate the full-year impact to be between $0.42 and $0.46, down from our previous estimate of $0.45 to $0.50.

All other full-year guidance metrics remain substantially unchanged.

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.

(Operator Instructions)

Adrienne Yih, Wolfe Research.

Good afternoon.

Nice job on the third quarter.

Sabrina, you will be greatly missed.

I mean, you've been a great steward of the Company, but even better, you've been a great person to work with.

I just wanted to say that.

Thanks.

Art, this is a question for you.

I wanted to know what your thoughts are about the much talked about denim cycle, how you can play that at the Gap brand and when you might see some real impetus behind that cycle becoming more prominent?

And then for Sabrina actually, with the loss of the unit, have you thought about the business as you plan for next year and whether you could and should be running with far fewer units in order to get better gross margin dollars?

Thank you so much.

Thank you and I couldn't agree more, first of all, with their comments about Sabrina.

I could talk a lot longer about that, but I know you have some specific questions.

The denim cycle I would say is, it's clearly hit bottom and bounced up.

We've talked about that.

It is an important part of what we're seeing at Old Navy right now and continuing to power the performance.

And then it's an increasingly important part of Banana's business and Gap's business as well.

It's not as consistent as I would hope it is and I see that across the whole industry right now.

It is, clearly she's refreshing her closet, but it's still not a strong dominant trend with super new news out there.

Obviously, with Gap, we will focus on that.

Stretch across all fabrications across the entire family is something that we are rapidly ramping up, both in the kids business as well as the adult business.

But we're hoping there is more front of us because it hasn't really hit in our view that turn up inflection point where it's really starting to power the business right now.

Sabrina, I will turn it over to you.

With regard to inventory, as tragic as the fire was, there were some really important lessons for us in that.

One of them for sure, Adrienne, is just when you think you're already running tight, that you can actually run tighter and bring those, that margin rate up in the margin dollars.

So, sure.

If we look into next year, we're trying to incorporate that lesson.

Now Q4 was obviously bought, most of spring, bought, but if we look forward to summer, fall and holiday 2017, I know the teams are really embracing the lessons from this fall holiday and very much are aligned in looking to continue to buy units very tightly.

Now that said, we don't want to get so draconian that you don't give yourself an opportunity to positive comp.

So we're always going to be walking that tightrope, but yes, for sure, it has been a really, really good lesson.

Okay.

Fair enough.

Best of luck for holiday.

Thank you.

Lindsay Drucker Mann, Goldman Sachs.

Thanks.

Good afternoon and, Sabrina, also, you will be missed.

Moving on, though, to my questions.

I wanted to ask about the merchandise margin improvement in the third quarter and how we should be thinking about the opportunity, the sequential opportunity in 4Q.

In other words, do you see as much opportunity for merchandise margin recovery in 4Q as you had in the third quarter.

And then secondly, on SG&A, you had a bigger increase in the third quarter than we were expecting.

Does that reflect some of those initial marketing initiatives that you talked about as impacting the fourth quarter and maybe giving us some perspective on what type of marketing you plan to invest in.

Thanks.

Sure.

So starting with the margin, we were obviously very pleased with the Q3 results.

A couple of things to point out in terms of differences between Q3 and Q4, Lindsay.

As we all know, Q4 tends to be much more promotional and competitive than Q3.

And then this Q3, of course, was unique because we lost a lot of units in the fire.

A lot of those units were fall fashion.

So we were super tight on fashion in Q3 and that likely supported the nice outcome on margin.

In contrast, in Q4, we didn't lose any holiday fashion in the fire.

So we still have basics and seasonal basics that were lost and supposed to be solved, but none of our holiday in any meaningful way was lost.

So we had more fashion in Q4 than we had in Q3.

Now if traffic improves, and we move the units, as expected in the time we want it, at the velocity we want it, then all is going to be well.

But as we mentioned, traffic has started out sort of stubborn and still challenged.

And so, I just sort of feel like, given those facts, it's too early to get overly optimistic.

Although, obviously the teams will be driving toward that some improvement year-over-year.

So that's the margin please.

With regard to the expense piece, there's lots of moving parts in expense.

Marketing was actually only up $6 million.

There were a bunch of other components, some of which are investments for the long term that the Company has decided to make.

Art mentioned, for example, the whole customer space.

And hiring a chief customer officer and what comes with that.

So we are starting to invest some, and then as I've been talking about for some time, since we are lapping many years of very tight expense management, it really gets super tough to try and leverage unless you have a very solid positive comp.

Art, do you want to?

I think you pretty much said it all.

We can provide more detail on marketing, probably not the best to go into all of it right now, but Gap's back on TV for the first time in a significant TV presence.

We have a catalog behind the Banana business that is dropping right now.

I walked out of the train station this morning to see a transit take over here which we're doing in a number of markets.

So it is a significant uptick in marketing, and as we said, hope certainly we get an immediate return, but we are not assuming that that is the case because we've got to get the flywheel turning again.

Great, thanks so much.

Matthew Boss, JPMorgan.

Thanks.

Just a lot of moving parts on the expense side into next year.

I guess what's the best way to think about timing and cadence of the expense saves and then just with wages and some of the investments offsetting part of this, how should we think about overall SG&A dollars in terms of moving forward?

I am not going to get into 2017 too much, Matt, because, of course, I will leave that to my successor, but I will tell you, remind kind of the actions we took this year and the shape they should take.

So the actions we took we said should result in annualized SG&A savings of $275 million, some of that coming in 2016, but probably most of that coming in 2017.

Now, what we said at the time is, again, after years of very tight management, part of the reason we chose to do that restructuring is because it would help offset some of the natural inflation that you get running our business and would allow us to continue to be disciplined in our operating expenses.

We are starting to make some decisions to make certain investments in the business, and I talked about one or two of those already in overhead and people in the form of people, and also in marketing, especially in Q4, and we will talk more or the team will talk more about what those investments look like as we move into 2017 on the Q4 call.

Got it.

And then just a follow-up.

At the core Gap, what level of traffic do you need to drive a potential positive comp and if you could just talk to some of the underlying trends that you are seeing beneath the surface, beneath the comp in terms of AUR traffic, just any green shoots that you're seeing in some of the new product potentially?

Yes, we said when we started the year that we knew traffic wouldn't jump to positive, so we were kind of planning on a low-single-digit negative, and with that kind of number and a healthy AUR, we could drive a positive comp.

That was the plan.

Unfortunately, traffic has been more tending toward mid- and high-single negative digits, and that's really been difficult for us to get traction on.

Art can talk more about what we see under the covers, but certainly it's encouraging to see that women, as the year has progressed, has been stronger than men's.

Year-to-date, margins overall have been healthy at Gap.

So those are some of the signs, but for sure, the progress has been slower than any of us hoped for.

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

Yes, I would just say part of the silver linings, such as there was with the, on the unit side of the business is it allowed us to really demonstrate and validate the pricing authority of the brand as we've tightened up and not had to move that many more units against a higher than expected negative traffic trend.

So it's actually given us pretty good validation of where we are from a product standpoint.

And then the other part of the validation is just the, we have a closed looped process of understanding consumers' perspectives on the product after they buy.

And the metrics there are moving quite nicely in the positive direction around fashion, around fit, and around quality.

And so I am cautiously optimistic.

Obviously, for bucking as the whole industry is overall, a traffic trend in the mid- to high-single-digits, that's a tough number to look at from the standpoint of pointing out a positive comp against that.

Great.

Best of luck.

(Operator Instructions)

Susan Anderson, FBR Capital Markets.

Hi, good evening.

Thanks for taking my question.

I was wondering if you could talk about the international business, maybe just give us an update there.

I know for a while, Gap US was outperforming the international, so just wondering if that's still the case or if you have seen international turn a little bit better.

Thanks.

Yes, I mean, the international business is obviously a composite of a number of different markets which have a variety of things going on in them.

Probably the most consistent theme obviously is continued FX pressure there.

And Gap is more exposed to that, as you know, than any other business.

If you look across the key pieces of the portfolio for Gap brand, the Japanese economy has obviously been challenging for everyone.

We have seen some firming up of the business, I would describe, recently, but we have a long way to go in order to get to the kind of performance we want to look at.

I talked about China in my remarks.

I won't really dwell on that.

Continue to be optimistic in the long run, but it's been, I think probably, the most promotional time we've seen in that market since we've been present there, with all of the relevant competitors, both local and non-local, breaking sale fall over or having sale go deeper and longer than we had previously experienced, which indicates the miss balance of inventory and demand right now that's in that market.

And then Europe continues to be Europe.

We've announced, obviously, the actions that we've taken there in terms of closing some stores.

We have a very good online business there.

The specialty business obviously carries a very significant rod on its P&L, and that's been an issue that we've had there for a long time.

So it's a real mixed bag.

And then in parts of the business in Canada, Canada's been very strong for us.

It's been a very good business.

So it's really a function of which market you are looking at.

Great, thanks.

Very helpful.

Good luck next quarter.

Thanks.

Ike Boruchow, Wells Fargo.

Hello, everyone.

Thanks for my question and congrats, Sabrina.

Best of luck going forward.

Just a question, I guess, the profit plan next year which was asked about.

And I think your exiting the Old Navy Japan business.

Just curious when you look through your portfolio, across all brands in all geographies, are there any other maybe geographies that aren't really hitting their ROI hurdle that maybe you have an eye on that maybe down the road over the next 12 to 24 months the business might look to evaluate as well?

Yes, I would say that when we announced the actions that we took earlier this year, we tried to really get at the things that we had line of sight to in terms of them not being strategic or not having a place to get to the kinds of returns that we wanted to see.

So I can't preview any other significant things that I see in front of us.

Obviously, we're living in a very volatile time right now and we will continue to reevaluate this as we always do on an ongoing basis.

But I would like to believe that we got at the great majority of the things we needed to get to over the course of the actions that we took this year.

Great, thank you.

Brian Tunick, Royal Bank of Canada.

Thanks.

Good afternoon and, Sabrina, we wish you all the best as well.

I guess, Art, two quick ones.

Just maybe on the supply chain, if you could give us an update there on what metrics you are seeing to help us understand the progress and maybe how much open to buy you have this holiday versus last year and where do you expect that to go?

And then secondly, on the share repurchase program, it's been such a big part of the story over the last couple of years, so I know you still have some of that revolver outstanding, but has the philosophy changed regarding the Company's capital allocation or a minimum cash position?

Thanks very much.

So let me actually address the second one first.

Our philosophy hasn't changed at all.

We've communicated clearly on the loan that we have outstanding.

And we have flexibility there.

But you have seen what we said about that before, and nothing has really changed on that.

We slowed down this year, obviously, on share repurchases against the volatility of the backdrop and what was a challenging environment.

We just felt like that was the prudent thing to do.

Our policy of returning excess cash back to shareholders remains pretty much intact.

I would say no real change and no discussion about changing that.

Right now, we want to just make sure that we can maintain flexibility as we see and hopefully as traffic firms up, et cetera, and we see performance stabilize, we get a sense of how the various things that are taking place in the world impact the marketplace.

We will come back and look at that as we go forward.

But I would say there is no fundamental change at all that we want to communicate with respect to our capital policy, our cash balances or anything like that.

Sabrina, do you want to add anything to that?

No.

I think that's.

I'm sorry and with that brilliant explanation of supply chain, yes.

Let me come back and talk a little bit about supply chain.

We've really, and this is what I said in my last remarks, maybe a quarter ago, is that we are continuing to move down a path, and I'm not going to go into a lot of specifics because it's really category by category, brand by brand, if you think about demand based buying, if you think about the responsive platform, et cetera.

And so the answer can differ to we're still buying one category on a traditional pipeline, like outerwear, but in other categories, like bottoms and mix, we have significantly improved the responsiveness of the category.

We're making excellent progress, and really, more of a challenge right now is the operating model of the businesses and being able to explode it.

Demand based buying is an example.

We're building tools against that right now versus doing it by brute force.

It's more about the front end of the business than really the back end of the business right now.

So I been pleased with the progress that we have made in our supply chain, facing our vendors, consolidating vendors, consolidating our base clothes, path forming fabrics, all those types of things.

And we're doing the front-end work right now.

But this, again, this is a season-over-season thing and I am seeing material meaningful season over season advancement in terms of these capabilities.

Operator, is there a next question?

Lorraine Hutchinson, Bank of America.

Thank you.

Good afternoon.

Art, you talked a little bit about the Gap brand and working on your pricing authority.

I was just hoping for an update on how you view your current denim and tops prices at the Gap, if you think you're at the right place and if any changes need to happen as you add more content to the product?

We're actually doing some pretty, pretty much, pretty deep work right now on pricing, so it's something that's really on my mind.

We did some work at Old Navy which we are now in the process of implementing which highlighted some pre-material opportunity and we're repeating that work inside of Gap brand as well.

I guess I would highlight a couple of things if I look at denim.

First of all, if you look at where we are from the standpoint of both our tickets and our actuals, we actually play in a pretty narrow range.

If you think about denim where it is, denim starts at an $8 entry level price point all the way up to multiple hundreds of dollars, and we, really across all of our brands, are very tightly banded.

So I think there is a breadth of fabrication, good better best, if you want to think about it that way.

The Gap has an opportunity to step up to in terms of product development.

And that's probably biggest on my mind right now.

The second issue is we have seen where we've been able to have pricing authority but it hasn't been consistent enough.

And that comes a bit with the quality of our buys and it comes I think with making sure again that we are dialed in and on trend across the entire buy.

I am really focus on denim from a market share standpoint.

And that's how we're thinking about it in the Company.

And I been very pleased with what I've seen at Old Navy where we have been on a consistent posture of gaining market share in denim, and we are doing the work both in Banana and Gap to make sure that those businesses are moving forward that way as well.

Again, if I reiterate, probably the biggest opportunities I see is the breadth of our development, and therefore, how we straddle where demand sits in the market place right now from a price point standpoint.

And we're pretty narrow relative to where I think we can play.

Thank you.

Randy Konik, Jefferies.

Thanks a lot.

Sabrina, it's been great working with you all these years and I wish you nothing but the best.

I actually have a question for you, Sabrina.

If you think about the merchandise margin improvement, I think you'd mentioned the bulk of it was from Old Navy.

Can you give us some, a little perspective on where we are in the respective merchandise margin cycles of each division, trying to get some perspective on where we are versus peak.

Obviously, if we can't go back to peak, where we are versus more of a normalized trend across three divisions, and when you look at the composition of inventory, I believe, down 4%, how does that composition look by division right now?

Thanks.

So, on the margins, I would say, since we don't segment report, Randy, I will try and give some color but mostly keep it at the Gap Inc.

level.

I would say that, if you exclude the impact of foreign exchange, which has hurt us for the last several years, especially Gap brand.

If you excluded that, we are actually not at horrible levels.

We're not a peak levels, but we are not at horrible levels of merchandise margins.

What I would tell you is that over the course of this year, as you all know from comp reporting and our sales reporting, Banana has had the most pressure over the last little while.

So directionally, they're probably the furthest from peak and directionally, Old Navy is probably the closest as they have been recovering and having some good business.

So hopefully that is helpful.

With regard to inventory, your question was around, remind me.

Yes, just the overall inventory is down, which very good.

I'm just trying to get some perspective on the composition, just a little color by division.

Got you.

Yes, it's almost, I would say, by channel.

So we have been buying very tight in the specialty channel, especially for Gap and Banana Republic, given they're a tougher business.

Old Navy, obviously, has also been very disciplined and bought very tightly, but that business is a business that moves units.

They are in the value sector, so we move a lot of unit, especially this time of year.

So they are probably, have more inventory, but from a historical perspective, are also still bought very tightly.

So specialty down the most, and then Old Navy and our outlets have a little bit more than the specialty channel, I would say.

Got it.

Very helpful.

Thank you.

Dana Telsey, Telsey Advisory Group.

Good afternoon, everyone, and, Sabrina, best of luck, congratulations, what a pleasure to work with you.

Thank you, Dana.

Art, as you were talking about the advantage of scale and that there is work still yet to be done, when does that pay off?

What does it look like?

Does it differ by brand and does it differ by front end and backend?

Basically, for both you and Sabrina.

Thank you.

Yes, Dana, I would say that, well, let me step back for a second and I'll just simplistically characterize the work that we are doing, which is we have operated this Company historically more as independent businesses with relatively separate but duplicative activities inside of each business.

Not entirely because we've had a common sourcing structure, a common IT platform, et cetera.

But in a lot of other places, it's been relatively more independent and the work that we're doing right now is to really build sort of a core operating platform by bringing all of those things together that are not customer facing and then skinning that operating platform where it faces the customer and the brand needs to be expressed.

And I've talked about that before, and that is a process that is underway right now.

And we're certainly doing that from a product standpoint.

We moved first in terms of product a few years ago when we moved away from a geographic base sourcing network to a category-based sourcing network so there's one office doing denim for every brand on behalf of the Company where we can then bring to bear our scale working with mails and vendors in order to get the best possible cost and the best possibly quality simultaneously.

It's been a bit mixed inside of other things as well.

I think we have an opportunity, especially in the environment we're in right now from the standpoint of real estate and our relationship with our landlords, and then there's just a wide variety of costs, some media that we buy and have bought separately, we're bringing together, et cetera.

So I'd like to, I'd love to tell you, give an exact number.

It is material.

And it will continue to progressively pay it out.

I mean, I have been very clear with the Company on this one that I want this done, I want it done ASAP, I want the benefits in hand, and then we will choose how much of those benefits we want to invest and how much of those benefits we want to bring to the bottom line.

Thank you.

Oliver Chen, Cowen and Company.

Thank you, Sabrina.

Thanks for the partnership and we will definitely miss you.

I was just curious about how you're thinking about interplaying marketing programs versus where you feel that your product is right now in terms of balancing that.

And Art, where do you think, at the Gap brand, where do you think the assortment is?

Are you happy with the alignment with where you want the brand to be in optimism and fit or which parts of the assortment have opportunity?

Thanks.

Where I think the product is relative to where marketing is I think Old Navy is lined up appropriately.

I think it shows in the business.

I think we have, I think the product is better than our business right now in Banana and Gap.

Not perfect by a long shot, but better than our business.

And therefore, it is why we made the decision to put some marketing into the business is to start telling the story.

When I was running Gap back in 2012, we fixed the product, we have strong trend and the business turned on a dime.

Obviously, I had hoped that that was going to happen here as the product better.

It's a tougher environment we're operating in right now with negative traffic.

Therefore, the decision to put marketing into Q4 and to make sure that we are budgeting marketing as we go forward as well really tell the story and tell the story about the product being on brand and on trend, but also about the restoration of quality, of fit, of technical attributes and those types of things as well.

I have a very strong conviction that successful brands today are story brands.

Is all around us and you can see the ones that are telling the story and the ones that aren't and we have a great story to tell, we've just been a little too quiet with Banana and Gap, by design, but we've been quiet until we felt like the product merited telling the story and that's really where my head is at right now.

I think I'll take the credit here for wanting to be conservative on marketing because I did not want to invite, aggressively invite customers back into our stores until I felt like the product was going to be where needed to be.

On Gap brand specifically, again, it's not perfect.

But the clarity of presentation that you should see in our stores where we have really tried to tighten up to a category merchandising, the trend that we have in our stores.

And I asked the question the other day of all of our brands, I sent a note over the weekend as I was traveling and watching and listening to people, I said just tell them we all had velvet and we all actually had velvet, which is super on-trend right now across every single one of our businesses, from Athleta, Old Navy, in the inner mix.

I feel like we are in a better spot and we are getting better season-over-season as well.

So I am, as I said before, I am cautiously optimistic on Q4 and I will continue to be as we look into next year.

Thank you.

Thank you.

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

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

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

Thank you.

Ladies and gentlemen, that does conclude today's conference.

You may now disconnect.