蓋璞 (GPS) 2017 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen.

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

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

Third Quarter 2017 Conference Call.

This call is being recorded.

(Operator Instructions) I would now like to introduce your host, Jen Fall, Senior Vice President of Corporate Finance and Investor Relations.

Good afternoon, everyone.

Welcome to Gap Inc.'s Third Quarter 2017 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 our forward-looking statements as well as descriptions and reconciliations of non-GAAP financial measures, as noted on Page 2 of the slide supplementing Teri'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 16, 2017, and we assume no obligation to publicly update or revise our forward-looking statements.

Joining me on the call today are President and CEO, Art Peck; and Executive Vice President and CFO, Teri List-Stoll.

As mentioned, we will be using slides to supplement our remarks, which you can view by going to the Investors section at gapinc.com.

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

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

Good afternoon, everyone, and thanks for joining us as always.

Teri and I are very happy to share with you today our Q3 results.

We had another strong quarter, delivering our fourth consecutive quarter of positive comps, along with our fifth consecutive quarter of gross margin rate expansion.

The momentum we're seeing in the business does give us the confidence to again increase our full year guidance.

Before I dive into the business, however, I do want to acknowledge that this quarter has had significant challenges, ranging from unseasonably warm weather and unprecedented impact of natural disasters and horrific events that have impacted our employees and our business.

I want to take this opportunity to recognize and thank all 135,000 of my coworkers who have been there for our customers while, at the same time, contributing tirelessly to their communities.

Our hearts and our resources are with those in the communities, which have still not fully recovered.

I'm also pleased to share that we protected all of our impacted employees with pay continuity.

This is a critical investment in our most important asset, our people.

In a moment, I'll turn it over to Teri, who will share more details on our Q3 results.

But before I do, I would like to reiterate our balanced growth strategy, how it differentiates us from the industry and how we're continuing to strengthen and sustain that differentiation, and I want to talk about some of the key components of it.

Balanced growth is made up of 4 pillars: number one, investing in growth in value and active, and importantly in active, that extends into the performance lifestyle space; number two, accelerating a large, fast-growing, highly profitable and accretive online and mobile business.

As we spoke to you in September, we indicated that we were on the path towards that being a $3 billion business, and we are very pleased with the results in terms of continuing to accelerate its growth rate.

I'll talk about -- more about that in a moment.

Three, continuing to reduce our exposure as a company to traffic challenged real estate through specialty store rationalization, largely in Gap and Banana Republic brands; and number four, substantially improving the productivity of the business.

Underpinning balanced growth are Gap Inc.

advantages that are helping us win: first, multiple iconic profitable brands that give us advantaged economics in finding, attracting, activating and retaining customers; second, the ability to meet our customers where they are and deliver an exceptional experience, whether that is online, on a mobile device or in our 3,300 stores around the world; third, leveraging responsive and innovative product creation capabilities to gain market share in loyalty categories; and fourth, continuing to identify and exploit our scale to drive profitable -- profitability, growth and deliver financial consistency.

I want to quickly discuss then our brands starting with Old Navy.

Old Navy delivered another very solid quarter up against high compares from last year with a continued focus on loyalty categories.

Denim was particularly strong, and I want to illustrate what drove the business.

The sales comps were on the high teens, and the margin comps were outpacing the sales comps.

As of October, Old Navy is the #4 retailer in denim, which is up 2 spots from LY.

Success has been driven by a number of things, including destruction, color, print, hem treatments and silhouettes that resonated with the customer.

But importantly, it was not just this product success, but it was the fact that Old Navy sits on a highly responsive platform, which allows replenishment in this category in 9 to 14 weeks, depending on whether we ship it on vessel or we air it.

As we continue to get faster, we will continue to see results like this as we reduce the risk associated with buying and holding inventory and where we can capitalize on demand.

And importantly, we will continue to get faster.

I'm also pleased to share that, in the last 2 quarters, we've developed a prototype of a low-scope, low-cost but highly effective remodel, designed to ensure that even our oldest stores in the Old Navy fleet will always be up to brand standards.

These remodels have delivered above their financial expectations and have had a positive customer response driving both top and bottom line performance.

Additionally, over the course of the year, we've opened 20 Old Navy stores in North America and expect to have about 1,070 as we exit the year.

As well, we are accelerating our new store openings in 2018.

Turning to Athleta.

Simply put, Athleta is on fire.

Top and bottom line momentum continues.

We're seeing exceptional growth outpacing the industry with operating margin expansion.

Many things are driving this but 2 stand out.

Back to responsive, 50% of the assortment in the business is on a pipeline of 6 to 11 weeks.

This allows us to responsibly buy the initial assortment and then feed units into the business as we see market share opportunities.

Second, we're making highly targeted and highly efficient marketing investments focused on customer acquisition, which continues to grow the customer file and continues to accelerate brand awareness.

Q3 was also an important time for the brand given the importance of back-to-school.

And you might ask why back-to-school matters to Athleta, but this was a real test to see the drawing power of the brand with the girls division now fully expressed in all stores.

And we were not disappointed.

And importantly, this business has been added with no incremental ROD and minimal expense, making it highly accretive.

On online, in Athleta, continuing to grow faster than the industry.

We continued to also thoughtfully expand our retail presence, opening 7 new stores this quarter and about 15 on the year.

We anticipate the total size to be -- of the fleet to be about 150 stores as we exit 2017, and we'll continue to open new doors into next year.

Turning to our more mature brands, Gap and Banana Republic.

The teams continue to be focused on improving performance while leveraging Gap Inc.'s capabilities to deliver innovation and on-trend product in loyalty categories.

Starting with Gap, the most important news is, again, progress quarter-over-quarter.

Importantly, we beat industry traffic during most weeks due to high returning marketing investments, and we also maintained healthy AURs as we've anniversaried the Fishkill fire.

We have more work to do, more progress to be made, and we're not celebrating success.

But the fact that we are seeing consistent quarter-over-quarter improvement makes me pleased with the results and the work that the team is doing and the consistency in execution.

In Banana Republic, the team is focused on the right priorities, but there's a lot of heavy lifting to do to improve performance.

Right now we're executing behind our product pillars, which translate into loyalty for the brand.

And as a reminder, the core of these are pants, suitings, sweaters and outerwear, things that customers expect from Banana Republic, come to Banana Republic for and are loyal to the brand for.

With holiday ahead, I'm particularly excited to see traction in the sweaters business to improve product acceptance and better investment.

Every quarter this year as well, Banana has been narrowing their spread to industry traffic with Q3 demonstrating continued improvement with a slight beat to the industry.

When you couple that with a positive sales, less traffic, it's quite clear that we are attracting more qualified footsteps and the customer is taking out their wallet and spending.

Again, lots to do.

We want to acknowledge the team is focused on the right areas and making progress.

If you recall from my comments back in September, a key focus for both teams in both businesses is getting each business back to a level of profitability that we have seen quite recently.

We're confident about the progress and confident about the work being done and anxious to continue to see the results improve.

Now I'd like to spend a moment on productivity.

First, we continue to make progress towards our announced store closure plan with a healthy portion of our planned closures now closing by year-end in 2017.

We also anticipate delivering on our initial planned closures by the end of 2018, which will be a year ahead of our original expectations.

We've looked at these stores through the lens of profitability and through the lens of their long-term potential.

We are making tough calls to ensure our fleet represents our brands and we are in the appropriate centers.

As we rationalize our specialty footprint, we're also taking the opportunity to drive a more efficient and profitable operating model for Banana.

We announced earlier this week that we're moving our New York-based Banana Republic teams to San Francisco.

This consolidation with the rest of the brand will improve speed.

It will improve quality, and it will save cost.

You will continue to hear from us on productivity each quarter going forward.

I wanted to share with you, however, a few of these steps that we have taken already.

Let me close with some comments on the investments we've been making and we'll continue to make to drive growth.

Over the past 6 months, brand health and customer acquisition have been critical focuses for every business.

We've accelerated the growth of our customer file database to the mid-single digits from negative, helping drive our online and mobile businesses to grow in the high teens in Q3.

Additionally, if you look at our online business, from Q3 of 2016, we have seen an acceleration of the growth rate in each quarter, quarter on quarter on quarter.

These investments are also driving multi-channel behavior with all of our brands beating industry store traffic in Q3.

This marks the third consecutive quarter for our traffic beat for Gap and Old Navy and the first for Banana Republic.

This is an important and excellent improvement compared to where we were even a year ago.

We've also continued to build on our features and functionality and capability in our web and app-based technologies to improve the customer experience.

Also, as we've had Ship from Store, Find in Store and Reserve in Store for several years now, this quarter we are -- we have added Buy Online and Pickup in Store to 2 markets, Chicago and San Francisco.

It is early days, but we're extremely encouraged by the results so far.

Beyond online and mobile, our multi-tender loyalty program, BRIGHT Rewards, is now live at Old Navy in Dallas and Atlanta.

Customers are heavily engaged so far.

With the test stores, we've seen a 2x lift in the number of customers we're able to contact versus our card-based rewards program.

This is an exciting step forward to be able to reach our engaged non-card holding customer and offer her a tiered version of our rewards offering.

As we look to holiday, we will continue to invest in our brands and channels in the form of marketing, digital and store payroll to drive growth.

Our performance year-to-date has given us confidence that this is the right thing to do and the right time to do it.

In closing, let me reiterate our focus on balanced growth, combining growth in value and active, accelerating online and mobile, rationalizing specialty while driving productivity improvements through scale and leverage.

We are driving this from a platform that is much stronger today than just a few years ago, and I'm pleased that we are delivering consistent performance this year as the foundation for future growth.

Teri?

Thanks, Art, and good afternoon.

As Art said, we're pleased to deliver another quarter of positive results while also making progress against the balanced growth strategy we outlined in September.

As you also heard from Art, as part of that strategy, we're accelerating our store closure plans and now expect to complete the initially identified closures by the end of 2018.

Additionally, we have and we'll continue to identify opportunities to leverage our scale and simplify our operating model.

We'll continue to update you on this work as we progress.

Turning now to the third quarter performance and starting with sales.

Comp sales were up 3%, marking our fourth consecutive quarter of positive comp sales.

Net sales for the quarter were $3.8 billion, a 1% increase from last year.

The spread between net sales and comp sales is largely due to our international closures last year.

We are very pleased to deliver another quarter of positive comp and net sales growth despite the negative impact from the hurricanes we experienced throughout the quarter as well as the warmer-than-expected weather.

Just for reference, as a result of Hurricanes Harvey, Irma and Maria, a combined total of 277 stores were closed for an average of approximately 6 days during the third quarter.

Looking at the brand level, Old Navy delivered a positive 4 comp against the positive 4 comp last year.

The last year comp excludes a negative impact of about 1 point from the Fishkill fire.

Similar to the first half, Old Navy's results were driven by broad-based category strength.

Continuing its sequential improvement throughout the year, the Gap brand comp was positive 1% driven by improved traffic and conversion.

This is against a negative 4 comp last year, again, excluding the negative impact of the Fishkill fire, which was about 4 points.

At Banana Republic, comps sales were down 1% against a negative 6 last year.

This excludes the negative impact of the Fishkill fire of about 2 points.

The men's business continues to be more consistent, while, as Art mentioned, the women's business has more work to do.

We feel good about continued traction in our pillar categories.

It's worth noting that all brands outpace industry traffic for the quarter.

This marks the third consecutive quarter that Gap and Old Navy traffic outpaced the industry.

We attribute this strength to improved and more consistent advertising.

Additionally, we were pleased to deliver our fourth consecutive quarter of positive AUR.

Moving on to gross margin.

When excluding the 2016 restructuring costs, our third quarter gross margin was up 60 basis points from last year to 39.7%.

Excluding the restructuring costs from 2016, merch margin was about flat to last year.

Our rent and occupancy leveraged 60 basis points, primarily driven by our positive comp sales.

With regard to Fishkill, as we noted on our second quarter call, we had expected business interruption insurance recovery of about $0.08 to $0.09 in the second half of the year.

During the third quarter, we've received about $0.03 of this recovery.

As a reminder, these proceeds are intended to offset elevated logistics costs we've been incurring throughout the year.

Our current expectation is to receive the remaining 2017 business interruption proceeds in the fourth quarter.

Regarding SG&A.

Our third quarter total operating expenses came in largely as expected at $1.1 billion, up about $80 million when compared to 2016 adjusted operating expenses.

Similar to the first half, the increase was primarily driven by payroll-related expenses largely due to bonus accruals.

We also saw an increase in investments to support the business, namely marketing and resources added to support our customer and digital efforts.

Our third quarter tax rate benefited from favorable changes in the tax impact of foreign operations resulting in a tax rate of 37.1% and about $0.02 of EPS favorability in the third quarter.

We now expect a full year effective tax rate of about 38%.

Our third quarter earnings per share were $0.58 compared to an adjusted $0.60 in Q3 of 2016.

FX negatively impacted third quarter EPS by an estimated $0.02, bringing us to flat year-over-year.

Regarding cash flow.

Year-to-date, our free cash flow was $197 million, which includes approximately $60 million of insurance proceeds related to property and equipment.

The timing of lease payments and the increase in inventory since the end of last fiscal year resulted in lower free cash flow versus last year.

We ended the quarter with $1.35 billion of cash.

Consistent with our commitment to return cash to shareholders, we completed an additional $100 million of share repurchase in Q3.

In line with our year-to-date cadence, we plan to repurchase an additional $100 million in the fourth quarter.

We ended the quarter with 389 million shares outstanding, and year-to-date, we paid dividends of $272 million.

Regarding inventory, we ended the quarter with inventory up 3% compared to the third quarter of 2016.

The increase in inventory is primarily due to the timing of in transit and the negative impact of foreign exchange.

Year-to-date, capital expenditures were $463 million, consistent with our expectations.

And on a net basis, we've closed 7 company-operated stores year-to-date and ended the quarter with 3,193 stores.

With our acceleration of store closures, we now expect about 30 closures on a net basis in fiscal 2017.

Now with regard to our earnings outlook for the remainder of the year, including the impact of the expected lower effective tax rate, we now expect adjusted earnings per share for fiscal 2017 to be in the range of $2.08 to $2.12, excluding $0.10 of insurance proceeds that we received in quarter 2.

Let me spend a minute on SG&A for the fourth quarter.

We now expect the year-over-year increase in fourth quarter SG&A to be at about the same pace of increase we've seen year-to-date.

There are a couple of factors that are impacting fourth quarter SG&A versus our prior expectations.

First, we now expect marketing spending to increase in the fourth quarter when compared to year-to-date trends.

This is largely due to the fact that we had some production costs move out of Q3 and into Q4.

But we're also planning some incremental spend, largely digital, to support the momentum we are seeing in the business during the important holiday season.

As I noted, we've been pleased with our improved traffic trends, which we believe are driven in part by better and more consistent marketing.

Given the positive results we've seen this year, we believe this incremental marketing investment will help us better execute during the important holiday season.

Second, we expect higher variable store-related costs associated with our objective of continuing to improve the customer experience.

And lastly, we continued to exceed our internal goals, and therefore, we expect higher bonus accruals in the fourth quarter.

We believe the investments we're making are supporting our balanced growth strategy, and as you've heard from us today, we're going to take the actions to fund these investments in the future by driving productivity across the company.

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

So in closing, overall, we are very pleased with the solid results in the third quarter, especially given the tough compares we were up against and some of the events during the quarter.

I'm also pleased with the progress we're making against our balanced growth strategy.

I'm energized by the plans and initial actions we're taking against the productivity goals we laid out in September.

The fourth quarter is an important one, and we're pleased to enter the peak period with strengthened brands, improved product and the operational discipline to deliver in a challenging environment.

That concludes our prepared remarks.

We will now open up the call to questions.

(Operator Instructions)

And our first question comes from Matthew Boss with JPMorgan.

So on the gross margin, what was the performance by concept that comprised the flat merchandise margin and I guess, how best to think about merchandise margin opportunity in the fourth quarter?

And then finally, just what comp is needed to leverage occupancy from here given the great performance this quarter?

Okay, I'll start with the last one, and I'll try to remember all the questions you asked, Matt.

The -- we've historically said we need a low single-digit to mid-single-digit comp to be able to leverage ROD.

I mean that's really what you saw this quarter, was we got that, and you saw it come through in the leverage.

On the margin questions, we don't get into as much detail as you would like us to.

But I can say, as we look across the quarter, there were no significant outliers in what we saw.

So we're seeing about what we expected, and we will remain focused on the AUR expansion that's helped drive some of the fundamentals we've seen this year as we go into the fourth quarter.

The only challenge, of course, is that the fourth quarter historically is more promotional, and so you're going to see that in the absolute rate.

But we are very comfortable with the healthy margins across the brands.

And our next question comes from Ike Boruchow with Wells Fargo.

Teri, I guess, this question's for you.

On the store closures, it sounds like you moved them up by a year, 30 net closures for this year.

How many of the 200 stores that you've laid out previously is incorporated in whatever took place in Q3 and your plan for Q4?

So we're -- this is how I'll answer it, is the 200 store closure that we laid out is a split between what we will accomplish over the fourth quarter, which is an acceleration and then spread out over next year.

And as you said, that is an acceleration of about a year.

We're going through the list of store closures now and finalizing the plans of the timing and how we will manage through those.

But net-net, we feel very confident that the acceleration this year and what we have planned for next year will take us through the finish line there.

So maybe just another way.

Is there a way we should be thinking about your net footage next year after all the store closure initiative takes place?

Yes.

We haven't gotten to that level of detail publicly.

Yes.

I would just say that, as you can imagine, this is a delicate dance that we're doing with our landlords, and there's a fair amount of negotiation going on right now.

And so as we start to harden this down, we'll certainly share the relevant and appropriate details.

But we're in the -- we're up to our eyeballs right now in the midst of what is really a constructive dialogue as we're working our way through this.

And our next question is from Brian Tunick with Royal Bank of Canada.

I was curious on the marketing spend.

Can you maybe just give us some perspective, by division, sort of what's happening year-over-year and how maybe you're thinking about where marketing investments should go next year?

And then second question.

On the fabric platforming that you've talked about before, obviously, you've given us a sense of where Old Navy is, but maybe give us an update on Gap and Banana.

Sort of where are they relative to Old Navy in your viewpoint on the fabric platforming?

Yes.

Sorry.

What was the -- I was listening then to the second question, flushed the first one out.

Can you go back on that again?

Advertising.

Oh, advertising.

Yes, advertising by division.

Don't want to go to specifics here.

I'd say the most important themes are -- is that we're continuing to move the mix towards a variety of forms of advertising, probably more away from the traditional print, et cetera and again, pivoting much more heavily into digital, where we can look at line of sight, we can get a clear measure of our ROAS and make intelligent calculations about how far down the ROAS curve we want to spend.

And that's probably the biggest change that we're continuing to implement across all the businesses.

We've had a very strong focus on 2 components, which is filling the funnel with new customers, and that is a consistent focus across the entire business; and then reactivating and increasing the frequency of lapsed customers or current customers.

And we're seeing excellent traction, to be honest, across all of those as we've gotten more focused and we managed the mix.

I don't want to put a pin in at the level.

But what I can tell you is, is that when we see the returns, which we are, and most importantly, they manifest themselves in terms of the accelerating growth rate online on one side and our beats to industry traffic on the other, we're going to continue to spend where we know that, that dollar spent brings us back a multiple.

It's just good business.

And then on the other side...

Fabric platforming.

Fabric platforming.

Yes.

I mean, if I rank them, what I would say is Athleta's probably the farthest along, and again, it's our smallest business and they've really gone after it with a vengeance.

And we're absolutely seeing business outcomes, as I noted, associated with their ability to be highly responsive.

And I would just, again, point out the fact that, as much as I'm giving you more specific numbers now and again, oftentimes, the spread is whether we air it or put it on a vessel on the ocean, we're continuing to look at ways to continue to get faster right now.

And sometimes, it's how to receipt faster, how do we get it to our DCs faster, do we start doing some direct vendor-to-store deliveries, that kind of thing because we're seeing absolutely consistent outcomes, excellent business outcomes associated with the speed.

If I rank order, I'd put Athleta first.

I'd probably put Old Navy second with Gap close behind, but it's a different business model.

And then it varies category by category.

And Banana still has some work to do, but the team there is really heads down on being a super fast follower from what we've seen in other parts of the business.

And our next question comes from Simeon Siegel with Nomura Instinet.

Just recognizing that you were lapping the compare from the fire, any thoughts on the right way to think about the go-forward Gap global comps into Q4?

And sorry for the dumb question.

Just to clarify, when you talk about traffic, is that store level?

Or does it also include online?

Yes.

I think on Gap, what I'm really looking for here, and I noted it in my comments, is consistent quarter-over-quarter improvement.

And we've seen that.

And I'm not going to call Q4 right now.

I mean, we're 2 weeks into Q4, et cetera, and I'm not going to call it.

But I can look under the covers and see why we're getting that improvement, and that's really what my expectation is of the business that we're going to continue to see.

Sorry, and the second one was?

I focused so much on...

Traffic.

Traffic, yes.

It's been a long week already.

Traffic.

So when I'm talking about industry traffic, that's really looking at physical traffic into our stores.

We don't really have the same kind of metrics as they apply to online traffic.

We look more there at overall demand and growth rates, but it's just a little looser there.

So when I say we've been beating industry traffic, it's really the standard industry traffic measures.

And again, really nice numbers from Gap and Old Navy pretty consistently, and nice to see Banana then in this quarter get on the bandwagon as well.

And the magic formula here is get traffic moving and then on top of that, sales less traffic, which comes out of your inbox levers around AUR, around conversion, around the size of the basket.

And that's the underlying formula that we've got going here now more consistently.

And I do just want to clarify on the Gap comp compare that we gave you.

It is adjusted for Fishkill, so the negative 4 last year is more of a normalized, so you can see the progress.

But the positive 1 is against the normalized negative 4.

Right, perfect.

Okay.

And then, Teri, just a quick one.

Have you -- the 53rd week impact to either sales or EPS, any help there?

Yes.

We said it's about $0.05 on the year.

(Operator Instructions) Your next question comes from the line of Kimberly Greenberger with Morgan Stanley.

Art, back in September, you talked about some SG&A savings opportunities that you see sort of medium-ish term in the business.

I'm wondering if you can just put a little more meat on the bone there.

And then I think at the same time you were discussing some SG&A savings opportunities, you were talking about other areas that you would like to invest in.

So could you maybe talk about that a little as well?

And on balance, do you think there will be some net SG&A savings?

Yes.

So I know you want more detail because -- for this question in different forms several times, and I fully appreciate that.

At the moment, I'm probably going to spend -- frustrate you a little bit to spend my -- but answer you back a little bit more with the process of how we're approaching it rather than the specifics.

And the way I would characterize the difference is that we, and many others, have often approached cost reduction on an episodic Big Bang basis.

And we and many others have had less success with that sticking and really getting efficiency and productivity in the organization than we should and then we will.

And so this is different.

We are taking, as I noted, the restructuring of the Banana headquarters structure, accelerating some of our stores, and then there's bits and pieces around the organization.

We are taking some of those actions right now but we're also really approaching this as an ongoing focused, highly managed productivity initiative that, quite honestly, as I said in September, we -- I anticipate this is going to live for several years and become part of our culture of how we do business.

And that has not really been as much of the culture as it needs to be.

On the investment side, I would note the things that Teri already called out, where we feel that we have an opportunity to differentiate, whether it's through customer acquisition or in-store experience.

I would also call out the fact that we are continuing to invest in the underlying capabilities in fulfillment in our distribution centers.

And I've talked about some of that before where we are investing in leveraging existing building capacity in our retail DCs to be able to fulfill direct orders out of those DCs as well.

And that really is meeting the continuing and accelerating demand that we're seeing in our online space.

And that's a big part of it.

There's technology investment, and there are other pieces as well.

But that's an important customer-facing piece.

Like I said, we'll talk about productivity, but it's going to be a continued conversation as we identify opportunities.

If and when we come up with an opportunity to say we're going to take a onetime by bundling things together, you'll be the first to know on that as well.

But we're in the middle of the work that we're doing right now and we still have more work to do.

And our next question comes from Anna Andreeva with Oppenheimer.

A couple of questions.

On the Gap division, Art, maybe what is your view on the product content right now?

And talk about what you're most excited of for the holiday.

And just a follow-up to the 4Q guide.

The SG&A growth rate implied pretty big improvement to the gross margin.

Maybe talk about what's driving that acceleration.

How do you guys think about the promotional stance into 4Q?

Okay.

Yes.

I think I heard you.

You got very faint in the second one, so if I'm off track, just stop me and correct me.

On the first one on Gap, what am I most excited about?

Again, I'd say consistency and period-over-period improvements.

If I dig inside of what's going on, we're seeing good traction in the bottoms business in women's, which is always an important place to see traction with denim really delivering right now.

And our denim platform in Gap is responsive and so able to put units back into the business.

Super solid traction also there in the active and in the performance lifestyle space, excellent traction in GapBody.

And we just opened a couple of stores now, one in the adjacent space in the Banana Republic store on Broadway in SoHo, where GapBody Love is being expressed.

And we feel there's a real opportunity here, starting with product, where we're very much on trend in the product space in that concept, and we're seeing excellent traction there as well.

And then to deliver the numbers that we delivered, you have to have decent progress across the whole business at the end of the day.

So -- but those are some of the highlights that I would call out.

On gross margin, it's a composite of things.

It's obviously product acceptance, which comes from the work that we've been doing now for several years on continuing to develop an assortment that is on trend, that is properly bought, that has the appropriate quality and the appropriate fit and do that consistently season over season.

And our customers are registering that and responding to it.

And that's number -- that's the, first and foremost, most important lever to beginning to get our yields up and back off of promotion, is the right product properly bought.

And again, that's a lot of the work that I've been talking about now for a couple of years with all of you, and we're starting to see business outcomes associated with doing that.

Where we are putting innovation into the product, we're also seeing that the customer is very much willing to pay for it.

And Athleta is an excellent example of that being a very high rate price business with everything in its assortment, whether it's lifestyle or performance, having elements of innovation.

But we're seeing that pay off, frankly, across all of our businesses.

Banana introduced the Rapid Movement Chino a couple of months ago, and it's been a blowout winner with men in what it delivers, which is stretch, comfort, performance and then stain management and water resistance as well, all in a great fitting, great-looking, pretty good classic chino pants.

And he's responding to that, and he's willing to pull out his wallet and pay for it.

I could go on and on about this.

But it's really all of those things.

If it was one giant lever that we successfully pulled, I'd actually be worried.

If it is the product of the diversified focus across better product, a better experience, product innovation, et cetera, plus traffic, that's -- I get pretty excited about that because that's the winning formula and it sits on a solid platform.

And our next question comes from Ed Yruma with KeyBanc Capital Markets.

Art, you've delineated the idea of performance lifestyle a couple times on this conference call.

I know highlighted the Rapid Movement Chino.

But I guess, how big is the opportunity for performance lifestyle?

And how should we think about the banner opportunity?

And where you think you can drive the most amount of business?

What I would tell you is that, as we continue to bring innovation, technical innovation that delivers comfort, care characteristics, active performance features, we continue to see the customer respond when we bring that into ready-to-wear fabrications.

And so I'm not going to call how high is high here, but we're very encouraged across all of our brands as we have continued to do this and see the customer respond.

And it's super interesting because it's just as relevant in a men's casual beach short as it is in a men's Italian wool suiting that might happen to have stretch in it or, coming down the road, that is washable rather than having to take it to a dry cleaner.

And that's actually a meaningful benefit for a man and a woman in that you save a lot of money, and there's a big convenience factor associated with being able to launder it yourself.

So as I talk about performance lifestyle, it's really, in some respects, sort of the reinvention of some of these ready-to-wear categories, drawing on the best of the active and performance space but expressing it in traditional silhouettes and traditional fabrications in the ready-to-wear space.

And it's a place where we don't see it happening, frankly, a lot.

There are some very small brands out there that are playing around with it.

We think we're one of the few actually doing it at the mass and scale level.

And it's been very encouraging so far to see how the customer is responding to this.

I mean, just to state the obvious, it's important that this product to be attractive, be occasion appropriate, not be weird, not be techy, not be crunchy but be a kind of product that you can wear as a traditional product maybe to work or a social occasion but also delivers performance attributes.

So that's kind of the magic where we really see the unlock and where the customer's really responding.

And our next question is from Chethan Mallela with Barclays.

So in September, when you provided detail on the margin profile by banner, I believe you disclosed the Gap brands had a very low single-digit operating margin in 2016 and I recognize that FX has been the headwind that can reverse and some of the planned store closure activity could also help future profitability.

But can you talk about other key unlocks that are specific to the Gap brand?

And then just as a follow-up, what do you see as a more sustainable margin for that banner over time?

Yes.

I mean, I'm indexing my expectations, and the team will tell you of my knee in their back in terms of improvement off of how the brand performed relatively recently, some of it under my time when I was actually running the brand.

And so without revealing the number, I can tell you that we have seen performance that is significantly better than what we're seeing most recently.

And the reason that's important for me, just to be clear, is that we can all acknowledge the secular trends surrounding the industry and those kinds of things and interpret those to mean whatever they mean.

As I've said before, I view this as money we have lost and therefore, money that is recoverable, and that's the work that we're doing right now.

And so I'm not -- I don't want to go into it right now because I don't want to set expectations, et cetera.

But it's definitely something that both Banana and Gap are looking at and again, indexing expectations back on recent performance.

If I say where should it come from with respect to Gap?

It's kind of all the above.

Clearly, FX has put pressure on the business, and we've delineated that.

We have some store closures that we're doing, which will help as well.

But it starts by, frankly, fundamentally continuing to make the product better to get our yields up, to get our promotional intensity down and to manage the cost structure inside the business.

And those are all things that we're working aggressively on.

And our next question is from Lindsay Drucker Mann with Goldman Sachs.

Art, in your prepared remarks, you mentioned an Old Navy remodel.

Could you give a little more detail, a, on what that's all about and b, how you're thinking about rolling it out?

And then just a quick housekeeping one for Teri.

The $0.03 from the Fishkill recovery, can you confirm if that's flowing through cost of goods this quarter or some other part of the P&L?

Yes.

Let me talk about the remodel.

The reason I'm calling this out is that we have a lot of stores in the Old Navy fleet that are still the original fitment.

We called them the old Old Navys, and you would recognize them with the circus-like signs and a supermarket-type cash register, booth sets that have been around for a while, et cetera.

And they're very typically very productive stores for us in locations that customers are still shopping in, but they look their age and maybe not -- maybe don't merit a full gut remodel.

So we've gone in, and we've done the relatively simple and the relatively low-cost things, typically starting with paint.

Oftentimes, we'll paint the fixtures, redo the lighting, perhaps remodel the cash wrap.

Sometimes, we'll even shrink the store down because it perhaps is too large, and so we'll build a false wall at the back to tighten up the store and make it feel a little bit more intimate.

And we've been rolling those out now with some tests before we pulled the trigger on deciding to go bigger, and we really found that the customer responds.

And first and foremost, oftentimes, they will say this is all-new product because it's displayed in an environment that is fresher and more respectful.

And as I said, we're seeing the top line lift and the bottom line lift, and so it's very encouraging to us.

And we've got a bunch of those in the system right now and we feel like our customers deserve and our product is so exceptional that it deserves a clean, fresh stage, and that's really what we're doing.

And it's encouraging to see the economics that come with it.

And the housekeeping matter, Lindsay, the $0.03 is in cost of goods sold.

It offsets the logistics costs.

Art, just you mentioned you have a bunch of the remodels in the system and you're seeing a top and bottom line lift.

Can you quantify any of that?

Maybe order of magnitude, what kind of top line lift or order of magnitude, how many of these remodels you've done already and how many you plan to do in 2018?

Well, we've done it more than a handful, I would say, right now.

And I don't -- I honestly don't have the numbers in front of me in terms of 2018.

What I can tell you is that there -- the returns on the expense, which is relatively modest to the CapEx, is quite good, so it allows us to put this down.

But I don't know the exact number right now, Lindsay.

I'm sorry about that.

Yes.

Over the course of 2017, we'll have north of 100 remodels completed, largely Old Navy but a couple of similar approaches at Gap and Banana.

And our next question comes from Dana Telsey with Telsey Advisory Group.

As you think about speed, what needs to happen to get faster?

When does it happen?

Is it a different pace for the different brands?

And what does it mean in terms of inventory and gross margin?

Just quickly on a second thing, with the high teens comps in denim in Old Navy, which is very impressive, how can the learnings from Old Navy perhaps be incorporated into the Gap division to improve their performance in denim?

There's nobody I would have expected more than you, Dana, to ask about speed.

And you delivered that question quite rapidly, so congratulations.

Thank you.

Thank you.

It's -- this is one that I know.

My responses on this continue to probably frustrate simply because there isn't a macro answer that makes any sense.

The averages here confuse because it is category by category, brand by brand.

As to how fast we can be, we are in places now constrained not by our design process and our vendors cutting and sewing but by the logistics associated with it, whether it's on vessel or, frankly, getting it into a port and then getting it on rail or on truck and into our DCs and out of our DCs and into our stores, so in some of these categories, it's why I said on the call, we're starting to look at ways to continue to chip a day, a week, whatever, off on some of these things.

And again, I would highlight on denim, it takes 9 minutes to make a pair of jeans.

And it takes a lot longer, obviously, from the standpoint of releasing a PO today to actually having that in front of the customer.

I'm not predicting we're going to be 3D printing denim in our stores in 9 minutes, but we see a continued opportunity here.

This is not -- there's not an endpoint.

This is an ongoing journey.

As to leveraging, we are leveraging today as a company better than what I've ever seen quite honestly.

I mentioned some of this before.

But we have converted our sourcing organization to a category-based focus versus having a variety of competing denim offices or knits offices all around the world.

We've significantly rationalized and are now sharing key vendors across the company.

In some cases now we are starting to share key base cloths across the brands that can be treated differently, washed differently, destruction, laser treatment, et cetera.

And so there's a big opportunity in front of us for continuing to share and then, obviously, sharing in terms of best practices as well, which we're also doing.

And again, I noted on Gap, Gap and Old Navy have been leveraging back and forth.

In Gap women's denim, we saw a 13 comp and a 22 gross margin comp, and those are really nice numbers.

And again, they happen for a lot of reasons, but part of the reason they happen is because we're increasingly responsive.

We're also on trend.

We've got good fit, good quality, et cetera, et cetera.

And our last question will come from Mark Altschwager with Robert W. Baird & Co.

So along the lines of focusing on the growth channels, I was hoping you could speak a little bit more specifically to the performance of your mall versus off-mall stores and any takeaways on the outlet versus non-outlet by division or whatever level of granularity you're willing to share.

Yes.

The level of granularity we're willing to share is probably a lot less than you would like.

Than you would be willing to take from us.

We don't get down to mall, non-mall kinds of performance.

I think there's no question, we have more of our specialty stores in some of the mall-based properties, and some of those are struggling more.

So as we rationalize those, those are probably a little more concentrated in the mall base.

But I don't know I'd go any further than that.

Yes.

And maybe just to close out, Art, maybe a softball for you.

But just wondering if you could talk about the broader apparel environment and how you're viewing it heading into holiday.

I mean, consumer's in decent shape.

Weather seems to be helping at the margin.

We're lapping the election and some tougher traffic from last November.

You've talked a lot about the controllable things that Gap is focused on, but just wondering what your crystal ball is telling you for the broader industry.

I mean, first of all, in the broader industry, we -- I continue to believe that there is and there is happening in front of us a consolidation taking place and that we are poised to win on the back of all of the advantages that we have and all the work that we've been doing, speeding up our product pipeline, innovating, delivering performance, all those things that are happening right now.

And so that's, I think, really important.

And I sort of view this as, almost regardless of consumer sentiment, we've got an opportunity to drive growth and gain market share.

My expectation, frankly, of all my businesses and all my business leaders is that we carry the momentum of this quarter into Q4, and that's -- everybody is heads down focused on making that happen right now.

And that concludes today's call.

Thanks for your participation.

You may now disconnect.