Tina Romani - Director of Investor Relations Art Peck - President and Chief Executive Officer Teri List-Stoll - Executive Vice President and Chief Financial Officer

Paul Trussell - Deutsche Bank Dana Telsey - Telsey Advisory Group Chethan Mallela - Barclays Brian Tunick from - Royal Bank of Canada Kimberly Greenberger - Morgan Stanley Matthew Boss - JP Morgan Randy Konik - Jefferies Mark Altschwager - Robert W. Baird

Good afternoon, ladies and gentlemen. My name is Lisa, and I will be your conference operator today. At this time, I'd like to welcome everyone, to The Gap, Inc. First Quarter 2018 Conference Call. At this time, all participants are in a listen-only mode [Operator Instructions]. As a reminder, please limit your questions to one per participant [Operator Instructions]. I would now like to introduce your host, Tina Romani, Director of Investor Relations. Please go ahead Tina.

Good afternoon, everyone. Welcome to Gap, Inc.'s first quarter 2018 earnings conference call. Before we begin, I'd like to remind you that the information made available on this webcast and conference call contains forward-looking statements. For information on factors that could cause our actual results to differ materially from the forward-looking statements, as well as the description and reconciliations of non-GAAP financial measures, as noted on Page 2 of the slides 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 May 24, 2018, 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 I mentioned, we will be using slides to supplement our remarks, which you can view by going to the Investors sections 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 today. I am pleased to report Gap Inc.’s sixth consecutive quarter of positive comp. Of course, we still have work to do as we always will, and we did face some challenges during the quarter. But before I get into that, I want to reiterate our commitments as I will over and over again to our balanced growth strategy. We’re focused on growth in the active and value space. We continue to responsibly rationalize our store foot in specialty real estate. We are investing in our online and mobile channels, a business for us that is $3 billion and growing. We're enhancing our productivity across the enterprise, and we’ll beginning to unlock the value of our customer data assets across brand and across channel. We’re well positioned on our unique and intrinsic strengths as a company, our scale, our platform and of course, our iconic brands. Looking at the quarter, let’s first turn to Gap brand. We discussed in March that we expected Gap brand to see some pressure in the first half, largely due to the carryover of operational missteps that we have talked to you about before from the last fiscal year. Teri will take you through the specifics in a moment, but I remain confident in the year and confident in the brand. We saw the problem, we took action. The performance of our other brands has met or exceeded our expectations despite cold weather. Old Navy had another quarter of broad-based strength with two-year stack of 11. Nearly all categories accounts positively and they continued in the first quarter of this year. We did see a slight drag due to weather. That said, it's important to know we saw dramatic improvement in trends when the weather turned late in April, and we’ve seen this continue into the second quarter. For Old Navy, we saw growth in nearly all categories with Denim having the biggest quarter comp in the brand’s history. We opened nine stores and are on track to reach our goal of over 60 Old Navy stores this year. And we’re seeing very positive customer response to over 40 remodels that we’ve done in the Old Navy fleet. Turning to Banana, and I would like you to turn to Banana. We are very encouraged by the momentum of the business and the brand's performance. Under Mark’s leadership, the brand has been leaning into the development of cleaner, better edited assortments that have a clear brand appropriate point of view. We’re seeing favorable customer response to innovation and favorable customer response to fashion. Banana has also been investing in quality yarns and fabrics without increasing materially the AUC of the product through our strategic sourcing and productivity initiatives. We’ve continued to see strength in sweaters, in bottoms and other loyalty categories, as well as significant lift in dresses during the quarter. We’re pleased with the progress at Banana and the team remains focused on driving momentum and consistency in the brand, and we believe that this has upside in our portfolio. At Athleta, I hope I say this and we’ll continue to say this. We saw another strong quarter with double-digit growth. And I believe that this gem in our portfolio, which is becoming a very nicely sized gem, remains underappreciated. In addition to solid growth we continue to build on our brand mission social responsibility. I want to underline this, because I believe that this is something that we’ll continue to talk about as we go forward. Athleta has become a B or benefit Corp certified. Certification requires meeting rigorous standards across social and environmental performance, accountability and transparency. This makes Gap Inc. the largest U.S. publicly traded retail company with a B Corp certified subsidiary apparel brand. Why does this matter? This matters because this is a critical component of Athleta’s strong brand identity and strong brand engagement. I'm very proud of the team, and very proud of the significant step that we’ve taken forward. Now, I’ll turn it over to Terry and she will provide some specifics around key financial highlights throughout the business. Teri. Teri List-Stoll: Thanks Art and good afternoon. As you heard from Art’s comments, quarter did present some challenges, some were largely expected like the Gap brand operating issues and other were less predictable like unseasonably cold and snowy weather. In the face of this, we were pleased to report our sixth consecutive quarter of positive comps. We continue to feel very good about the balanced growth strategy, and the underlying momentum of the business, which allows us to maintain our outlook for the year. For the quarter the issue that Gap brand drove the majority of the gross margin to leverage. As you know, Gap brand has been undergoing significant operating model improvements over the past year, and there have been changes to both processes and people over that time. And while we’re confident these changes will prove to be positive over the long run, the customers steps for the spring summer season. The root cause of the challenges is not significant product acceptance issues, but rather operational miss steps around timing of inventory received, breath of the assortment and lack of gaps in some categories. On last quarter’s call, we talked about being heavy on inventory and Gap brand heading into Q1, which impacted gross margin as expected. In addition, we had some receipt flow issues that compounded the problem. Throughout the quarter, the timing of inventory flows affected the time on offer and the ability to optimize margin. We’re addressing the issues that affected margin in the quarter. We expect pressure to continue into Q2, but not to the same degree we experienced in Q1, as we’ve already moved aggressively to enter the back half in much better shape. During the quarter, we made some strategic decisions to aggressively clear inventory through sell-off. We also incurred some expense as we proactively cut CCs originally planned for the back half. While these actions negatively impacted margin rate in the quarter, it does set us up for cleaner stores in Q2 and better inventory positioning for the back half. Now most importantly, we’re re-instilling operating discipline and leadership accountability across the organization. In February, we announced the appointment of an interim leader for Gap brand with extensive operations experience, and he is doing an excellent job with the team to ride the ship and ensure the second half we gain some momentum we’ve been seeing prior to these operational issues. So now, let me turn to the first quarter performance. And I’d like to note our first quarter reported results include the impact from the adoption of the revenue recognition standards. And as a reminder, the adoption isn’t expected to be impactful to our earnings, but it will change the classification of certain line items in our P&L. The most significant impact comes from the recognition of income related to our credit card and loyalty program. And historically, this income was classified as an offset to SG&A and COGs. But under the new rules, we are presenting this income in sales. For the first quarter, the accounting change resulted in an increase of $141 million to net sales, an increase of $91 million to gross margin, as well as $92 million increase in operating expenses. To be helpful, we’ve included a slide in our quarterly earnings presentation and a table in our press release that details Q1 2018 results with and without the impacts from adoption. Both can be found on the investor section of gapinc.com and of course will be available after the call to help with any modeling question. So let me start with sales. Due to 53rd week in fiscal year 2017, for consistency, our Q1 2018 comparable sales are compared to the 13 week period ended May 6, 2017. On this basis, the Company’s comp sales for Q1 2018 were up 1%. As I said, marking the sixth consecutive quarter of positive comp sales. Now, we haven’t quantified the weather impact on the quarter, but after what has been reported to be the coldest winter in several years and the snowy in April in 21 years, should assume weather negatively impacted the quarter. As you would expect, the Northeast, where weather was particularly unseasonable, heads off to performance. Our net sales for the quarter were $3.8 billion. When excluding the impacts from the adoption of the new rev rack standard, this represents growth of about 6% over Q1 2017. On this basis, a little more than half of the five point spread between net sales growth and comp sales was due to the impact of the calendar shift created by the 53rd week in 2017. As a reminder, this year’s first quarter dropped a small week in February and a larger more full priced selling week in May. Now at the brand level, despite unseasonably colder weather throughout the quarter, Old Navy delivered positive three comps against last year’s very strong plus eight. We are pleased to see another quarter of broad based strength across all categories, and positive AUR as Old Navy continues to grow its market share and solidifies position as a top apparel brand. We also were pleased that Banana Republic delivered a positive three comps against negative for last year. This is the second consecutive quarter of positive comp for Banana as it continues to focus on pillar categories. Similar to Old Navy, Banana achieved growth in nearly every category. At Gap, comp sales were down 4 against negative 4 last year for the reasons we talked about. And as Art mentioned, the trend in both Athleta and in our online business, remained very strong. Despite the gap impact, we were pleased to deliver our sixth consecutive quarter of positive AUR growth, driven by old navy and Banana Republic. Turning to gross margin. On a reported basis, gross margin was 37.7%, $91 million or 100 basis points of expansion was driven by revenue recognition adoption. Excluding net impact, first quarter gross margin declined 120 basis points, driven by merchandise margin decline of 180 basis points, partially offset by 60 basis points of rent and occupancy leverage. The merch margin was at the lower end of our planning scenarios. Some of the wet weather impact but the majority was due to the strategic decisions we made at Gap brand to more aggressively clear inventory. This accounted for about $28 million or 80 basis points of merch margin deleverage. The remaining deleverage was driven by higher promotional activity at Gap brand. Rent and occupancy leverage was primarily driven by the shift caused by the 53rd week last year. On SG&A, again on a reported basis, first quarter total operating expenses were $1.2 billion. The adoption of rev rec resulted in the $92 million increase in operating expenses, and accounted for 130 basis points of operating expense deleverage. Excluding the impact from the adoption of rev rec, first quarter SG&A leveraged about 10 basis points, also benefiting from the calendar shift. We remain focused on productivity and total high level expenses during the quarter. The entire company is engaged in how we can drive operational efficiency. These efforts increased the quality and efficiency of our processes and free up funding for growth investments. A good example is store technology where we’re adding new mobile devices that improve our in-stock levels and speed up the check-out process, both levers that can improve conversion and deliver growth. Moving to taxes, our first quarter effective rate was 25.1%. The lower rate was primarily due to the geographical mix of earnings and we continue to expect a full year effective tax rate of about 26%. On earnings, our first quarter earnings per share were $0.42, which included the benefits and the calendar shift created by the 53rd week last year. FX did not have a material impact on earnings per share. Free cash flow was negative $204 million, which reflect the higher bonus payout versus last year. We ended the quarter with $1.4 billion of cash, cash equivalents and short-term investments, comfortably within our target cash threshold. Consistent with our commitment to returning cash to shareholders, we completed $100 million of share repurchase in Q1, and paid dividend of $94 million. We ended the quarter with $387 million shares outstanding. We ended the quarter with inventory up 4% compared with the first quarter of 2017. This incorporates some lower in-transit inventory effect due to timing. While we are heavier on inventory at Gap brand than we would have liked, overall, we feel good about where we ended the quarter for the Company. Regarding capital and store count, our capital expenditures were $138 million. On a net basis, we’ve opened six company operated stores to-date and ended the quarter with 3,171 company operated store. In line with our strategy, openings are focused on the value and active space, while closures will continue to be weighted towards Gap and Banana Republic specialty. While there were challenges in the quarter, Q1 results were within the range of scenarios embedded in our initial full year outlook. We are affirming our full-year earnings per share guidance range of $2.55 to $2.70. Although, clearly our ability to get to the high end of that range, will be more challenging given the Q1 start. As I have noted, when we saw weather trends improve, we saw a dramatic inflection in trends across the portfolio and we feel good with our start to Q2. With regards to Gap, as we said last March, we expected challenges to pressure the first half. And we continue to expect margin pressure in the second quarter, but not to the same degree we saw in the first quarter, given we’ve had the chance to impact the quarter. While we do not guide the gross margin at the Gap Inc level for Gap brand, we do expect merch margin pressure to be about half of what the brand experience in the first quarter. We said that some degree of quarter variability is evitable, considering our portfolio brands and macro factors. We are making the decisions that we believe are consistent with our balanced growth strategy, which is the right path forward for the Company. We still have opportunities to improve as already indicated, particularly as we work through the operational issues with the Gap brand. But the underlying fundamentals of our portfolio brands against our strategic priorities remain strong. Just a couple of housekeeping matters before I turn it back over to Art. Regarding the 53rd week, as a reminder, our annual guidance range includes the negative impact from the loss of the 53rd of about $0.06. We do not expect the timing shift caused by the 53rd week to have a meaningful impact on the second or the third quarter. Just as the first quarter benefited from the calendar shift, the fourth quarter is expected to be negatively impacted by more than the shift benefited Q1 due to the loss in third week. And then on the adoption of rev rec and our guidance, in March, we provided full year 2018 guidance for net sales spread and SG&A as a percentage of sales. Specifically, we note that for the full year 2018, we expect spread to be flat to up slightly as we expect a loss of the 53rd week to be offset by new store sales growth and the translation benefit from foreign exchange. And SG&A, as a percent of net sales, to be about flat if productivity offsets increased investments. Just to clear up any confusion, because there are lot of moving parts and everyone reporting these days. This guidance holds when looking at year-over-year comparison on a like-for-like basis with and without the impact of revenue recognition. So with that, I am going to turn it back over to Art.

Thanks Teri, appreciate it. This is for those of you that attend this call on an ongoing basis, this is where it ends. But I really do want to underline a few points here and obviously we’ll open it up for questions. A few points that are important to me, and I believe super critical to the overall investment thesis of the Company. First, I cannot underline enough our balanced growth strategy. We are heads down, executing against it. Teri outlined the components. We’re going to continue to push down that path and I have absolute conviction that it is the right path for the Company. I want to talk about productivity for a moment. And we’ve talked about this, Teri mentioned this, I want to underline it and point out to you my conviction about the opportunity and my conviction about the fact that we will deliver against this opportunity. We did note that there was expense leverage in the quarter and some benefit from the 53rd week. But in line with guidance, the entire Company is taking an intense consistent and ongoing look at how we drive operational efficiency in our cost structure. Real estate is another critical area and we spend a lot of time talking with you about real estate. We continue to optimize the fleet, and we will continue to optimize the fleet, including reducing exposure to low productivity stores wherever they are, but these largely are mall base and are represented by the specialty portion of our footprint. At the same time, we do see a store growth opportunity, and we will continue to invest in stores where we can achieve quality, growth and quality profitability. In some places, that means opening new locations, largely in the value and active space, meaning Athleta, Old Navy and the factory and outlet expressions at Banana Republic and Gap. We’re also renovating some current locations that are healthy and productive, but where we know we can see even greater upside. We’re starting to see the results of the work, and 2017 store traffic outpaced industry trends all year and that continued into Q1 across the portfolio. I also noted that we have a large and fast growing online and mobile business. It’s a critical component. It is one of the largest online apparel businesses in the world. And it is one we have deep conviction to continue to grow and continue to invest in. We’re also investing in store technology. We’re adding new mobile devices that can improve our in-stock and service levels, and speed up the check out process. We’re also lighting up, in Old Navy, buy online and pickup in store, which we believe has the opportunity to continue to unlock how the customer shops seamlessly across both of our channels. We believe these levers can improve conversion, and we’re investing in digital experience and fulfillment initiatives beyond this that enable us to engage with our customers in a more meaningful way. In closing, I want to reiterate the confidence that Teri and I both have in the strategy and in the Company. We outlined this last fall and it has remained steadfast and unchanged. We’re focused on balance growth, continuing to support accelerating growth in active and value, supporting and investing in our progress in digital and accelerating the growth of our digital business, and how that connects to customer experience, rationalizing non-performing real estate and driving SG&A productivity. The last point that I want to underline is one that -- honestly there has been relatively little dialogue, but it’s still material and important. And that is the benefit that we receive from tax reform changes. As I noted in our end of year call, this does open up significantly the earnings capacity of the Company. Thank you. And now we’ll open up for questions.

Thank you, sir. We’ll take our first question today from Paul Trussell, Deutsche Bank.

You outlined a number of issues impacting the Gap banner business. Can you just rank for us what was most impactful to the banner in 1Q, and what exactly is improving to alleviate the margin pressure as we go into the second quarter and will allow for a bounce in the business in the second half? If it’s the inventory position improve processes, et cetera. Teri List-Stoll: Obviously, over the course of the quarter, we were able to impact a number of the components that brought us to where we were in Q1. Meaning we were able to stabilize the processes, we were able to get in and try to address some of the inventory issues. But just because of the lead time that exists, we simply were not able to get through it all. And that’s part of the reason we made so much painful decision to strategically sell off some of the inventory and just get it clean. As we got in there and realized that there was an addition to the flow timing, there was an assortment issue. We just ended up being more over assorted than we think is good for the brand and the stores were just not clean enough to allow our customers to really see through to the probably the brand and product we have there. So as part of that, we made a decision to job out some inventory and then we worked aggressively to start cutting forward receipts. But some of that will come through in Q2, which is why we see the moderating effects, but it won’t be all the way bride and tell the second half.

And let me add a little bit to that, because it support and I think it’s a really critical question. So just to build on Teri, rightsizing our inventories, we wanted to accelerate the movement of units to the business and we took action, which we felt maximize the yield out of all those units. But it was inside of our stores were jobbing inventory out. My experience now has been, and this is universal, is if you have too much inventory or the wrong inventory, holding onto it does not make it better. And so we were decisive on that and took those actions. It wasn’t with our pain, but we believe it was absolutely the right thing to do to continue to clean up the business and position it for better performance as we get into Q2 and then into the back half. So that was critical. We’ve also narrowed and cut back on CC and style assortments as we get into fall and particularly in holiday. What allows us to do is; number one, clear point of view and the stores; secondly, more depth behind our big key items and our drivers, which is always important in this business. There were also some technical issues as we’ve been standing up our inventory assortment and allocation tools, and we identified those and have resolved those. And those were not immaterially important in many of the late POs that got -- that were being placed, and we’ve resolved that largely fully as we get into the back half. So there's a number of material things that we did, knowing where we wanted the business to be. And again, we took action quickly and decisively to make those changes.

Really quick follow-up, I just wanted to touch on the slide in your presentation that shows quite strong one line growth. Can you just speak about the drivers overall to the acceleration this past quarter and perhaps which beginners are contributing the most of that growth? And then lastly on online, just curious if you can speak to the margin profile of that business today?

The thing that makes me most pleased to talk about the acceleration and strength of the online growth is that it’s not one thing or one brand. It is very diversified across our portfolio, and it is not predicated on one specific aspect. If I could just tick through a few things, we’ve continued to focus on growing our customer file, starting with customer information capture in our stores and the other aspects that we bring customers into active relationships with the company. We’ve had an enterprise wide executive on that now and it’s -- enterprise wide incentive on that as part of the bonus structure now in its second year, and we’re getting significant traction on that. That's related to our traffic and to our file size. And then it’s a wide variety of things, whether it's service-level on our basic products, improving our site load speeds, continuing to improve our app experience, which now is all closing in on five stars in terms of their rating, continuing to tune and tweak and test our checkout process, our navigation process. I mean what the reality of the online businesses is that it is about a constant set of incremental improvements, none of which turn the trajectory of the business, but all add up to see what I hope you find we do to be a very satisfying acceleration of the growth rate of the business across the portfolio.

[Operator Instructions] Our next question comes from Dana Telsey, Telsey Advisory Group.

As you think about the Gap brand and the changes going on there. What do you think in product acceptance that gives confidence in the improving trajectory at Gap? And also, anymore color on Banana, what you’re seeing there and same thing for Old Navy? Thank you, bye.

Thanks Dana, it’s a very good question. And let me just talk across that. And this was very much on my mind. We mentioned the weather challenges. You know what the weather has been like as it was in Q1 where seasonable cool rain, snow et cetera. Obviously, a number of people, including us, saw that that had some impact on the business. Not being one to casually play the weather card, I spend a disproportionate amount of my time in our stores and looking at our product reviews across all of our brands online, digging super deep to see if we were fully ourselves, or if there was actually some product acceptance issue. Now you know, we will never have all of our product perfect, but I also know that I have a sufficiently good relationship with the stores that if we have product issues, they are going to tell me about it when we go in the stores. And I did not come away with a belief that there was a significant product acceptance issue. There is a style here, a color there, et cetera, but we feel good across the whole portfolio that we actually had strong product that was on trend and probably assorted. Now in Gap brand, the issue was as we’ve noted, the net of the impact of the receipts CC and style expansion that did result in the fact that the stores looked and felt and were over-assorted. I think the change in the stores has been obvious as we've taken some of the inventory levels down and got to some of the styles and CCs out. And what’s left is product that can breathe seasonally appropriate and we’re seeing the customer respond to it. And again, I can say key categories worth working, the body business is very strong, we’re seeing good strength in bottoms and particularly in denim. When the weather turned, we saw the shorts business come back online across the company. So Gap no significant problems. In Banana, the assortments has and will continue to quiet down with some of the excess detail and fashion frills being removed from the assortment, the color pallets has quieted down back to where Banana should be, which is a bit of color in print on a platform of sophisticated, easy to wear and versatile neutrals. We've improved the fabrications, our customers responding to it. The dresses business is very strong as are several of the other businesses. And so we knew that when we made those changes, the customer is going to respond, because the feedback was clear and we're seeing exactly the response that we expected. And then the men's business has continued to chug along, and is quite solid there. With the notable issue in the men's business that as we've continued to introduce innovation, largely at the fiber yarn and fabric level with our stretch fabrications but our 37.5 fabrication, et cetera. We've seen men responded in a really good way to the innovation that we're bringing into ready to wear apparel. Old Navy, I was in there in mid-April and I was wondering, do we have too many off the shoulder tops and dresses. The weather turned and we've seen the sell through go to where we expected them to be. We had probably a little bit of over assortment in some prints and women's dresses. And again, we've moved through those issues; she's responding across the assortment; Denim is good; kids and baby business is solid; and the men's business continues to chug along as well. And then in Athleta, again, strong performance; swim is important in this quarter; and swim was not quite as strong as we wanted it to be; I mean, it's not a huge driver in the business; but that's the one place where we've looked at and said, geez, we've probably got some issues there relative to the color palette, et cetera. But largely and holistically, I am very pleased with our product acceptance.

Our next question will come from Chethan Mallela, Barclays.

So I wanted ask about the gross margin performance in the quarter, and it’s clear that Gap rent and the inventory clear out had a sizeable impact. But can you give us a sense of how margins trended, excluding those issues and how you think about gross margins once you get past them? Teri List-Stoll: So as you think about gross margin for the quarter, once you sort through all the economy changes and so forth. You have to remember that compare on gross margin is actually against a very healthy improvement in Q1 of last year. So we already are against a pretty quality compare. And so as we think about -- I'm not going to dissect it down, to take out the various components. But I would say, you can probably get some sense of the impact of those. And then as we see that moderating, the Gap brand and impacts moderating in Q2 and then moving to the back half, we have no reason to believe given the AUR strength we’ve been seeing, the focus we have on AUC that we wouldn't get back to a more typical margins with opportunity to continue to focus on how we expand those by focusing on our loyalty categories and driving growth in places where we have clear opportunity to win.

Next up we'll hear from Brian Tunick from the Royal Bank of Canada.

I guess Art, I was curious on two fronts. One, maybe to hear your thoughts, other people that are talking about a fashion cycle emerging right now, and obviously, you're talking about record denim result. So curious if you're seeing, or the organization thinks, we're on the cusp or seeing a fashion cycle or a big shift happening? And then the second point, you've talked about market share opportunities before. So it sounds like fast fashion no longer gaining market share. Do you see opportunities in the same malls, or strip centers where you’re located? Thank you very much.

So on the fashion cycle, I’m hearing about that as well. And honestly, my experience is that you can find whatever fashion cycle you want, if you look hard enough and talk to enough people. What we’re really seeing is continued solid growth and consistent expenditures across the key categories in our business versus any particular distortion. Now, there's a little bit of a 90s fashion cycle that’s out there that absolutely plays to the strength of our brands. In Banana, there's a little bit of a utility and Safari cycle out there that we’re continuing to build in as we get into the summer and fall, and that's obviously the heritage of the brand expressing that in a really nice sophisticated way, and she and he are responding to it. We don't see right now, however, any significant distortion. I mean, the Denim business is strong across rise and silhouette, midrise we’re seeing high-rise business which we bought into as well. There's some wide leg pants silhouette out there. But it's a smaller trend and it’s not a hugely democratic trend. So we actually feel like we’re well invested with depth behind our ideas in key categories in the business, and don't see something that is flash in the pan distortion right now. The market share we are seeing, I believe, comes from a combination of things, being on trend in our key categories, being well priced in those categories, delivering value that the customer understands and relates to, and then offering a super easy and convenient and accessible shopping experience across mobile, online and in our stores in a way that is converge. So it allows her to engage our brands in the easiest way that's possible, which to me is all good news, because it says that solid consistent execution is what is going to carry the day, and that is very much what we’re focused on. And I think you asked a second question or a part to that, which I -- in my incredibly informative answer, I have spaced, but maybe not…

No it was along the same lines about how fast fashion is giving us there as well.

I mean, it’s still out there certainly. And whenever I hear fast fashion, I say you need to tease apart fast and fashion, because part of the work that we've done in our product delivery capabilities has been about getting faster. I think that we do see a backlash a bit in disposable fashion. And this is something I mentioned in my remarks, purpose driven brands, it's been a buzzword. We see it becoming more and more of a reality. And it’s certainly manifesting itself most significantly in Athleta. The great majority, part of being B Corp certified in Athleta with the great majority of the product is on sustainable fabrications. And we find that the customer is responding to that. So that a little bit of a backlash against the waste and disposability is something that I think benefits our business where across all our businesses we have always stood for a quality that the customer understood and items that lasted.

Kimberly Greenberger from Morgan Stanley has the next question.

My question is on the outlets. But I just wanted to clarify something first with Teri, if I could. I think with -- it's on the ROD leverage in the quarter, I think you said 60 basis points of ROD leverage. But if I look at the 6% sales growth, I just would have thoughts perhaps there would be more ROD leverage in there given that back in the third quarter, I think you cited 60 basis points of ROD leverage with only 1% growth rate in revenue. So I just want to make sure I heard that right, and if you could talk about the why the ROD leverage wasn't better. And then, Art, on the outlets, obviously, you talked about pursuing quality growth. And I am just wondering, do you think that the outlet growth, in particular, for Gap and Banana Republic, could be cutting into your specialty business and basically driving some of the declines in that specialty business? Thanks.

Why don’t I answer that first and then I’ll turn it back to Teri on the ROD leverage question. It’s a really good question to think about what’s the right proportion of outlets or factory stores to the specialty stores. And it is something we look at. We have data that helps us understand cross-shopping patterns. And obviously, outlets have moved from intentionally un-convenient geographic locations to be now more urban and suburban locations. So there is probably some impact. That said, we do have very attractive economics in our outlet channel. So the impact is something that we’re very comfortable managing our way through in terms of the impact that it has on our economics, if we intelligently and responsibly manage our commitments to specialty real estate. And that is what we've been doing now for over a decade. That all said, the bigger impacts on our specialty business and specialty fleet and this is -- starts first with Gap, is the fact that Gap has been around for a long time. And as customer shopping patterns have changed, many of those stores that were productive 20 or 30 or even 40 years ago, are now in malls or locations that have been bypassed by job patterns, education patterns, housing patterns, et cetera. And so that's the work that we've been doing. It’s largely driven by getting Gap out of places where customer shopping patterns have bypassed the real estate. We’ll always manage the ratio of outlets to specialty very carefully. So I think we’re pretty comfortable and I am with where that ratio stands today. Teri, let me turn it over to you. Teri List-Stoll: Kimberly, on your ROD question, so we’ve been saying that we need a mid single digit comp to leverage ROD, so that we’ve been pretty consistent. You see a lower threshold. But as we’ve deployed incremental capital to store growth and some of the investments we’ve been making to set ourselves up well for growth, that has moved more towards mid single digit. And so that’s pretty much what you’re seeing flow through in Q1.

Next is Matthew Boss from JP Morgan.

I guess, Art, at the core Gap if we look at the operational mix there. Is it fair to judge the brand by your back-to-school assortment that we were thinking about products, as well as performance? And are you -- I guess, Teri, are you embedding positive comps at the Gap concept in the back half of the year. Just how best to think about the progression of same store sales from $0.04. Teri List-Stoll: So as you think about the momentum we started to see in the Gap brand last year, we actually ended up in Q4 with a positive comp and we had been building from that with investments we've been making, including some stepped up advertizing. And so were seeing improved traffic comps and just a better overall engagement with the customer on the brand. And so those dynamics are still there. Our traffic remains better than the industry on the Gap brand, and so the issue that we’re seeing is the inability to deliver on the expectation of the customer given our inventory issues. And so I don't have a specific guide for comp for Gap brand in the second half. But I would say if you look at the fundamentals and then you take out the issues that have been affecting the inventory in the Q1 and we expect to continue to lesser degree in Q2, there's no reason that we wouldn't quickly get back to the momentum that we're seeing in. And one of the things we've been doing is because we believe in the brand and we believe in the fundamentals, while we're being super disciplined down the cost structure and the business, we're not cutting back on things that are fundamentally important to sustaining the brand health that we've been building back up. So that we can be as well positioned in the second half to get that positive comp that we saw in Q4 of 2017.

And I would just underline the fact that we talked -- we saw Gap’s issues before we formulated our guidance for this year. We reiterated our guidance as we have seen Gap’s issues and gotten our arms around them. And then to your specific question, Matt, on back-to-school, as back-to-school aligns with the beginning of the back half, that is when we feel like we're largely out of the operational issues. And changes that we've made in terms of inventory assortment, breadth, CC and style count should start to impact. Teri List-Stoll: Matt, I just want to go back. And so I think I said Gap brand was positive in Q4, they were positive in Q3 back of flat as we get up. I apologize for the miss statement there.

Just a quick follow up on the expense front. I guess, how should we think about SG&A dollar growth in the first quarter relative to the balance of the year? And just larger picture, do you believe you have the right investments in place today to drive operational performance going forward, or anything that we would think about larger picture in terms of incremental investments that you'd like to make?

Let me talk about the incremental investment and then we can -- I can hand it back to Teri on the expense growth. I mean, we've obviously indicated our appetite for both our CapEx and our OpEx. So let me use Fishkill as an example. We’re in the final stages of standing up the rebuild of the Fishkill facility after the fire. That is significantly upped our game in terms of the automation of that facility. In terms of receding -- stocking the inventory, picking the inventory and then shipping the inventory, and that's something that we've had and intend to do for a while. It improves our efficiency and our effectiveness through our fulfillment operations. Another one is we're continuing to invest in bringing the relevant technology and putting it into the hands of our sales associates in our store. We’ve talked BOPIS, which is in Old Navy now, which we're going to continue to roll across the fleet. We have a really exciting on-shelf in-stock app that we've now deployed on iOS devices in our stores that is an exception based restock app, tied to -- especially a redesign of our stock rooms. And we're seeing so far in the very early days a significant improvement in on-floor service levels and the reduction in payroll. So we get an efficiency benefit as well in terms of the re-plan hours that we spend keeping our stores in stock. And those were a couple of examples. Do we have all of the right investments? No, there’s probably 2x what we're spending if I met all of the demand across the organization. But we do feel that responding -- spending at a responsible level that we have set the right priorities this year and as we go forward in terms of where we're applying that investment. Teri List-Stoll: So on SG&A, we provided the guidance that for the year we expected SG&A as a percent of sales to be about flat. And that reverses the trend where we have historically over the recent past we’ve been deleveraging somewhere around 170 basis points. And so what you’re seeing in the first quarter is a dramatic reversal of what we saw in Q1 of last year. In fairness, it is helped by the 53rd week but still it does show that the work is starting to take root and we’re getting some of that expense to been under control. While as I said investing in the initiatives that we believe are highest priority to deliver the best return to the enterprise.

Next up from Jefferies is Randy Konik.

Art, hate to beat to the dead horse here. So can you just go back on the historical timeline just so overall on the call of where of what the actual issues were at the Gap from a process standpoint, when -- why did the processes change? When you identified those issues? And the processes are either going back to what they were before they changed? Just want to just get some more specifics there, just so we can put this issue to bed as we move forward here.

It’s a really good question, and I thank you for giving me the platform for talking about it. So we’ve been moving, as I’ve been talking to you about for a while, across the entire company as we’ve continued to accelerate our product processes and reduced our time from concept to shelf. And that's largely gone quite well without any bumps in the road. And I’ve cited several examples across the company where that is manifesting itself in the form of business outcomes, not the least of which in a small way, but increasingly large way, Athleta’s bottoms complex that went from 60s week 60 to eight to 10 weeks, and is allowing us to fuel that growth with units. So that’s an example. And we have been doing it all the way across the company. Adjacent to that is we’ve been standing up a new tool from -- that is basically applied against the assorting and the buying and allocation process of our business to modernize our inventory management capabilities. And we’ve been implementing that and getting it online by module in different parts of the Company. And one of the modules inside of Gap as we were speeding of product processes we ran into some, both process issues and capability issues and some technical issues, which resulted as we saw in Q4 some late placements of PO's. And essentially just to be simple about it, we’re requiring more discipline and more precision in the specification on our products upfront so that we can then release those to our sourcing office and to our vendors in final form. Previously in a system that was much more informal, there was lot of iteration that went back and forth on POs that released to get to the final products back. So it actually yields a better and more disciplined process and can continue to help us accelerate. But change management and some technical issues resulted in a fact that getting those POs right before they were released upstream meant that we ended up with many of them being late, and that's really the issue that the biggest issue from a technical and process standpoint that we've been wrestling through. The second component of that was the relentless creep of style and CC count. And that -- we added with all the best intent some styles in CCs. And the combination of those two things resulted in the inventory issues that we had, as well as the over assortment issue that was very evident in many of our stores. While we took the action on inventory very quickly, it’s why going forward, we have whacked back styles in CCs. It allows us to deploy the buy more productively behind our big ideas. And I'm quite confident that we have resolved the technical and the capability, and the process issues that were conducted to the late POs in the first place. A logical question that you would ask is, am I going to see this issue pop up elsewhere in the company, and the answer is absolutely not. We have run this with the ground. We know what it is. We have resolved it. And as I said, we expect to see this behind us as we get into the back half year.

So just to pull all together, you’re saying the PO problem is done. The inventory is still heavy at the Gap. I thought those been worked on, we should get those in line with trend by the end of the second quarter, such that we should expect core merchandise margin to do what it’s going to do based on product acceptance in the back half and not be impacted by any type of technical or project issues.

On natural pressures…

Yes, all right. That’s really helpful. Thank you.

And I just want to -- let me just -- go ahead. I just want to finish up on this one, because it’s important. That's correct. I also just want to underline the fact that there is pressure in this quarter, as Teri noted, from the fact that we took very swift and very decisive action on inventory. There is always a temptation in this business to say okay I got as, I’m going to write it out, and I will sell it, and I’ll have a big sale, and all those kind of things. We looked at it and we said, we want to get this done. We want to get it clean. And we want to get behind us. And we’re not perfect right now. But by taking those actions, I think you can see if you go into our stores, you should see stores where particularly in the women's assortment, the product is now clear, the ideas are clear and the product and breath. Again, inventory is not perfect but we took a significant one-time correction to get it done and get it behind us.

Okay, our next question will come from Mark Altschwager, Baird.

I was hoping if you could talk about Old Navy for a moment, and just where you see the most opportunity from a unit expansion standpoint and the near-term. And I was hoping you could specifically address the strategy with respect to competitor exits? With some upcoming department store closures and otherwise underserved and maybe small and medium-size markets, but seen there some pretty identifiable share opportunities out there. So curious how you’re thinking about that and may be leaning into it? Thanks.

Yes, we are highly aligned on our perspective. So thank you. I really appreciate you taking this up. So if you think about market share, I have a very simple model in my mind, which my team now has, I made sure, has in their minds as well. And that revenue comes in varying degrees of quality. And I think about it in concentric circles. And the bull's-eye in the concentric circle is a dollar of AUR that goes through our existing stores, because that dollar should have a drop rate that is darn close to 100%, from the standpoint of income -- revenue to income. And we are not in Old Navy and our other brands. We are not -- we are significantly focused on how do we continue to improve our AURs, and Teri spent some time on that. Part of that is mix, as we continue to invest in categories that drive higher AURs, growth in the bottoms business. Growth in Denim is a great example of that, and that's where we continue to gain market share. And part of that, obviously, is yield, where we are very focused on yield management, and making sure that while we are appropriately promotional that we continue to focus on yield management, and every dollar possible out of every unit that goes through our stores. So the energy of the business starts with how do we get maximum gross margin dollars out of every square foot of existing real estate, which is a fixed cost. That is a very high quality revenue. The second piece of that is adding additional categories or units to our stores. And we are doing that now. Part of what we get out of our responsive capabilities, and this is a big part of what's driving Old Navy's Denim business, is we're able to feed units in close into season and take advantage where we have a hot trend, where we have a hot silhouette, where we just see good traffic in order to drive units through those stores. And so we continue to see a unit growth opportunity in Old Navy and in our other businesses, but in Old Navy, as we continue to invest in the key categories and put the depth behind and drive our business; and that's bottoms; that's knits; that's the active space; that's kid's and baby, et cetera. A third piece is to add new categories to our stores, and we will always look at doing that and we are an Old Navy. We added active a couple of years ago that was significantly accretive to revenue and profitability. And we're always looking at places to say how do we actually get a higher share of wallet, and build out a bigger opportunity. We had another Denim set inside of the box, which has helped us continue to expand the Denim business in the women's. We're looking at assortment opportunities also inside of men's. And so that's the construct, which is first and foremost, leverage our fixed cost base by AUR and additional units to our business. That's a big opportunity for us. And as Old Navy gain share, it's very high quality revenue. And then there's additional square footage. And we do see an opportunity there. We said we're on track for 60 new units this year of old navy. Those are largely conventional stores, no trickiness at all associated with them. And some of them are infill in major metropolitan areas. As an example, here in the Bay area, there’s an Old Navy store going in Concord at the Veranda, which is a new shopping center that's cropping up, very close to an existing Old Navy store. And we're interested but different traffic patterns, interested in reading that, so we see significant infill opportunities, that's part of the 60. And then we brought our targets down around size of metropolitan area, and we are finding that there are smaller population areas that do to closures and mall closures and consolidations are underserved today where there is a very nice Old Navy opportunities. So we have not put a specific storable out there, but we're very bullish and very encouraged by the opportunity to continue to build more units. And we do look at the off price space and their unit count, and see that Old Navy is significantly underrepresented and we think there's upside there. So again, super bullish on it. And then the last thing I would say is do not underestimate the importance and the power of the online business. Old Navy has the lowest penetration but it's important and it continues to accelerate in its growth rate and it just a material growth driver for this company that has excellent economics.

And ladies and gentlemen, that is all the time we have for questions today. That also concludes our conference. We do thank you all for your participation. You may now disconnect.