Tina Romani - IR Art Peck - President and CEO Teri List-Stoll - EVP and CFO

Mark Altschwager - Robert W. Baird Matthew Boss - JPMorgan Dana Telsey - Telsey Advisory Group Randy Konik - Jefferies Lorraine Hutchinson - Bank of America Merrill Lynch Chethan Mallela - Barclays Capital Kimberly Greenberger - Morgan Stanley Oliver Chen - Cowen and Company

Good afternoon, ladies and gentlemen. My name is Celestina, and I will be your conference operator today. At this time, I'd like to welcome everyone to The Gap, Inc. Second 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, Senior Director of Investor Relations.

Good afternoon, everyone. Welcome to Gap, Inc.'s second 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 two 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 August 23, 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 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.

Hi, everybody, and thanks for joining us for the call today. We are pleased to report our seventh consecutive quarter of positive comp sales. You know, our quarterly results came in largely as we expected them to, and we are positioned for continued improvements in the back-half of the year. Today I will talk through some key highlights, and Teri will, as always, follow-up the detailed results for the quarter and guidance for the remainder of the year. But before we discuss the performance of each brand, I would like to pull us up for a moment and talk just a bit about a broader view of our foundational assets. First, on our supply chain, and I'm not going to dwell on this for a long time today, but this has been a huge focus of mine from the moment I stepped into this role. And we have made huge strides forward in terms of responsiveness, platforming, testing, vendor consolidation, quality improvement, and product cost. There is no question that this is an important factor powering Old Navy's consistency, Athleta's growth, and Banana's continued turnaround. These are real capabilities driving real outcomes. Second, and I have to be honest here, it perplexes me to continue to hear over and over that stores are a liability. They are an asset, not a liability. Sure, and if you have got a store in a dying mall, that store needs to go away, and that's the work that we have got on early, and we will continue. But the simple factor is that most apparel is still sold in stores, and will continue to be sold in stores. That said, the definition of shopping continues to change. She wants to do more than just walk in, pick a product, and exit. She wants to find something online and pick it up in a store, be checked out in the fitting room, will place an online order in a store. It's important to continue to emphasize that we are delivering a suite of capabilities for her to shop and engage our brands today the way that she wants to. Stores are the deepest form of customer engagement. And one thing the industry is not talking about, which is super important to me is that they are source of an immense amount of customer data. I will come back to that. And we are bringing technology to bear to solve some old-fashioned problems; simple things like I can't find my size, style, color combination. This not being able to find your size is one of the customer's biggest frustrations, and to address it, we just rolled out what we call an In-Stock On-Shelf app, which informs proactively the store associates on their mobile device when items need replenishing. I think about it as we are getting the benefits of RFID without the expense and hassle of RFID. After deploying the solution in all U.S. Gap stores, the rate at which an item is available in the store but not on the floor, decreased from 40% to just 1%. This satisfies the customer, drives conversion, and increases labor productivity. It's a win-win-win. So far we have also rolled out this solution for a select category at Old Navy with full fleet rollouts planned for Athleta and Banana Republic in the second-half of the year. In another example of how we are taking friction out of the shopping experience, this quarter Old Navy rolled out Buy Online Pick up in Store, or BOPS, nationwide, and we have seen customers using it, and quite honestly, absolutely loving it. Early response has been super positive with about 20% of the customers making additional purchases once they are in the store, and nearly 20% of the customers using the service were customers new to a multi-channel experience, meaning they previously had shopped either online or in-store, but not in both. We know the value of a multi-channel consumer, and this behavior results in a more loyal, more valuable customer. Beyond driving highly qualified traffic into our stores, there's also an important accretive effect on the P&L. When online is integrated into the in-store shopping experience, we get the margin benefit above the line of the profitability of the online business without the variable shipping experience below the line, because we are leveraging our store footprint. Most importantly, it is profitably, I would underline, giving our customers exactly what she wants, and while it's still early, Buy Online and Pickup in Store is one of the levers that we expect to support continued top and bottom-line expansion in Old Navy, and is a building block in our back-half growth plan. We also continue to improve our mobile app experience, and this is important, because she's not just using this at home, she's using it in our stores. This quarter we launched a scanning feature within the app that lets the customers easily scan a barcode to read reviews, find additional sizes and colors, and if the item isn't available in her size or color in the store, then have it shipped to her home. This work is driving increased customer engagement and sales via the mobile app in the first-half of the year more than doubled compared to the first-half of last year. All the above demonstrates how we continue to and have brought our stores together with our third asset, our large fast-growing and very profitable online business. That business cost crossed the market $3 billion last year. We're on track to reach $3.5 billion this year, and we've taken investments capability, technology and training to deliver a seamless, low friction, high-touch and cost-effective experience to our customers regardless of where she shops. We're actually a leader at this. It's driving our growth and our profitability, and we believe we are just getting started in seeing the economic and customer benefits. Now let's talk about our fourth asset, which is again largely not talked about. I sit here on the Bay area surrounded by new economy companies who entire business model is data. They know that data is a scale asset and the more that you have, the more value you can extract. Because of our size and our scale, we have an immensely valuable data asset that we're just beginning to exploit. We have two billion customer visits across our brands and channels. We have a co-branded and private label credit card that gives us great intimacy with those customers. We have customer information capture incented in our stores, and in the subset of our brands and stores we have client telling. The value of converting all of this data to insight and action is huge. A simple example is that migrating just 1% of our single-visit customers to be multi-channel, multi-brand represents $200 million of top line on an annual basis. One way we're doing this that is encouraging our customers shop across our brands and channels is through a multi-tender loyalty built on the back of our data assets called BRIGHT. This quarter we expanded the program across all brands in California, and the early results have been very positive with over a million new members, and will continue to test and expand as we gain experience in how to best optimize and frankly monetize this program. In addition to BRIGHT, we have many other efforts underway to leverage our data assets and to maximize the lifetime value of our customers. I'll take a moment to highlight just a handful. We now have a longitudinal 360 view of our customers through data and analytics. We're leveraging this into personalization to create a more relevant digital experience. The rollout of personalization features across our brands is being staggered as we continue to learn more and operationalize it, but we have already deployed personalized experiences to over 250 customer segments, which has resulted in a 5% improvement in conversion when compared to a non-personalized experience. We're also using data and knowledge of our best customers and have moved the majority of our marketing spend into digital channels where we can be surgical in acquisition, activation, retention, and frequency. It's driving a growth in our customer file, growth in our traffic and growth in our business. And it's improving the productivity of our marketing spend at the same time. To sum it up, I see our supply chain as a powerful, scaled, fundamental asset that is key to our sustained growth. Our stores are another asset, they're still where the majority of purchases are made and they allow us to engage with our customers in deeply personal ways. Our digital business is large and only getting larger and finally the combination of our stores and our online business generate an immense and powerful data asset that we're only beginning to exploit. Now let me turn to the performance of our brands beginning with our growth brands Old Navy and Athleta. Old Navy grew market share again this quarter and in Q2 as the eighth largest apparel retailer, second largest apparel brand in the United States. We're seeing incredible strength in brand health metrics and Old Navy is continuing to pace towards our $10 billion net sales goal. The store traffic outpacing the industry and up again for the quarter. We're also seeing great traction in our new and remodeled stores. We've told you this was a priority and we continue to pursue it and year-to-date, we've opened 28 stores and completed 85 remodels. As a whole, new store performance is beating expectations and remodels are outperforming the fleet by an average spread of five comp points. Old Navy's product engine continues to be the foundation of its success. The process is rock solid and is key to delivering consistency in the business. Once again, we saw a broad-based strength across nearly every category with all divisions gaining market share during the quarter and remain a market share leader in dresses, knits, shorts, and pants. Super exciting news, and we announced this just a couple of days ago which is that Old Navy will be launching its plus collection previously only available and smaller online into 75 select stores. For some context, the women's plus-size market is north of $20 billion and is growing above the rate of the overall apparel market. Old Navy has a strong foundation in this business with a dedicated plus collection that has been available online for over 14 years. NPD says that even with just the online business Old Navy falls within the top 10 women's plus-size brands and expansion of the category in the stores represents, we believe, a significant growth opportunity and is in line with Old Navy's inclusive democratic brand values, or as we put it, and I would encourage you to check this out, #SizeYES. Let's move to Athleta which delivered another market share gaining quarter and is progressing well against our $1 billion sales objective. This brand continues to excel in engaging and connecting with new and existing customers and in Q2 the new customer growth rate continued to accelerate, a sign of a healthy, solid growth brand. No brand is perfect, and Athleta did see some softness in swim this quarter. The good news is that we're largely out of the category for the back half and from an execution perspective, we used our responsive capabilities to pivot in-season to the high growth bottoms business. In fact, the bottoms business, which represents nearly half of the assortment, delivered a high-teens comp during the quarter. Performance within the girls business has been nothing less than phenomenal, and they're playing in the back-to-school space this year. The brand recently released their Stay in the Game campaign emphasizing girls' confidence building through sports and activities. I really encourage you to look at the video, which powerfully captures everything the brand stands for and how Athleta deeply engages with their customers. Now let's move to our more mature profit focused brands beginning with Banana Republic. The work the team has done to restore brand health is paying off and I'm seeing that in the numbers, this was Banana's third consecutive quarter of positive comp and very importantly, that comp was coupled with healthy margins. I would encourage all of you to get into the stores and to see what the assortment looks like. It is more consistent and it is better executed and our customers are responding. Taking a page from the Old Navy playbook, we've shifted to an occasion and event driven strategy with cohesive product, marketing and commercial plans all focused on the customer. I'm quite encouraged by the momentum we're seeing and the team is heads down focused on continuing to drive the business in the back half of the year. Finally, Gap; in June, we announced that Neil Fiske would join our team as President and CEO of Gap brand. In the short six weeks time, I'm impressed with his ability to take the baton and run. He's completely focused on stabilizing the business and simultaneously improving operating discipline. The Q2 comp trend in Gap brand was unacceptable, but it reflects a conscious choice to optimize margin dollars as we continue to manage through inventory. We were able to cut 30% styles in CCs for the second-half. And in hindsight, we believe this is very much the right decision, but it has left us with some imbalances heading into the fall. As I have said, we will see continued improvement at Gap brand as we move through the year, and that remains the view. Quarter-by-quarter, we expect performance to improve, and we believe the worst is behind us. Lastly, I want to spend a couple of minutes on productivity, and Teri will talk about it in a little more detail; actually just a few seconds on productivity, because I need to turn it over to her. We delivered the second quarter of improved SG&A trends, and we are on track to exceed our internal productivity goals this year, which I am very pleased with. In closing, the quarter turned out largely as expected with continued strength in Old Navy and Athleta, observable progress at Banana, and continued work necessary to stabilize Gap brand. With that, Teri, I will turn it over to you. Teri List-Stoll: Thanks, Art, and good afternoon everyone. So I kind of look at our quarterly results through the lens of our balanced growth strategy, are we executing against the priorities we agreed, are we seeing the progress we expected? While we continue to have opportunities for improvement, we are pleased with the progress we are making, and confident in the appropriateness of our priorities. Specifically as you heard from Art, our focus on growing and the value in active space is working, demonstrated by the continued strength in Old Navy and Athleta. Our investments in our digital business and customer experience will provide a unique and seamless shopping experience that will support continued differentiation and growth. And we saw some specific examples of that in the quarter. Underscoring these efforts is our heightened focus on improving the profitability of our specialty fleet as well as our productivity initiative. These efforts not only benefit our current results, but will truly optimize processes to create a more nimble and efficient organization going forward. Obviously, we have to acknowledge the challenges at Gap brand, the business is not yet where it needs to be. Team remains focused on where they can have the most impact to optimize margin dollars and deliver continued improvement through the back-half. As we reflect on our historical performance, simple put, there have been too many instances where the businesses suffered because we failed to execute effectively. This is a key priority going forward, and we are using the current Gap experience to establish stronger operating discipline across all of our brands, often leveraging the best-in-class processes at Old Navy. We do remain confident in the balanced growth strategy and the focused actions that it drives. We are maintaining our outlook for the year against the backdrop of first-half results that were largely in line with our expectation. So let me turn now to second quarter performance. And as a reminder, our reported results do include the impacts from the adoption of the new revenue recognition standard and these changed the classification of certain line items in our P&L. For the second quarter, these presentation changes resulted in an increase of $139 million to net sales, an increase of $95 million to gross margin, and a $94 million increase to operating expenses. To be helpful, we have included a slide again in our quarterly earnings presentation that details the Q2 2018 results with and without the significant presentation changes from adoption. This can be found on the investor section of gapinc.com. As always, Tina and Claire will be available also after the call to help with any modeling question. So starting with sales; first, some housekeeping, throughout the year, we are aligning our comp sales reporting to adjust for the 53rd week in fiscal 2017. Accordingly comparable sales are compared to the 13-week period ended August 5, 2017. As Art said, we delivered our seventh consecutive quarter of positive comp with a plus two for Q3 and a plus three on a two-year basis. Net sales for the quarter were $4.1 billion. When excluding the presentation changes from the adoption of new Rev Rec standards, this represents growth of about 4% over Q2 2017. Also on this basis, spread for the quarter was largely driven by new store openings and translation benefits from foreign exchange. At the brand level, as Art said, Old Navy had another strong quarter delivering a positive five comp. This brings the two-year comp to 10%, and represents the third consecutive period of double-digit two-year comps. We continue to see broad-based trends in the business with growth across all divisions in nearly every category. The engine of the brand's sheer growth is the momentum in our loyalty categories: Denim, Kid Baby, Active. At Gap, comp sales were down five against negative one last year. Obviously we are not pleased with this performance, but as Art said, it reflects the conscious choice to prioritize margin dollars over comp growth as we continue to move through the inventory issues and the brand. Importantly, we did see sequential progress from Q1 in key markets. Banana Republic posted its third consecutive quarter of positive comps with the plus two comp against last year's negative five. Notably, the brand delivered meaningful merchandize margin expansion in the quarter with the mid-single digit improvement in AUR. We continue to be very encouraged by Banana's performance. Their focus on improving the product and providing a compelling experience for customer is really resonating. The Athleta fundamentals remain strong, while slim as a soft spot. The rest of the business continued its double-digit comp trends. And as Art mentioned, the growth trends in our online business remain very strong bolstered by the digital investments we are making. We are on track to reach over $3.5 billion in online and digital sales this year. Moving to gross margin, on a reported basis, gross margin was 39.8%, $95 million or about 100 basis points expansion was driven by the presentation changes from Rev Rec. Excluding that impact, second quarter gross margin declined 10 basis points, driven by a merchandize margin decline of 70 basis points, partially offset by 60 basis points of rent and occupancy leverage. As anticipated, merch margin de-leverage was driven by Gap brand. While we continue to work through the inventory issues as previously identified, we did see the sequential merch margin progress at Gap brand during the quarter that we expected, and we continue to expect sequential progress over the back-half of the year. In addition, we have seen some cost pressure from shipping expense in the first-half, partly due to start-up impacts as we turn on our new automation at our Fishkill Distribution Center. As we fully operationalize the new equipment and technology at Fishkill, we expect this pressure to moderate in the back-half. Rent and occupancy leverage was primarily driven by sales growth. Regarding SG&A, on a reported basis, the second quarter total operating expenses were $1.2 billion. The presentation changes from Rev Rec resulted in a $94 million increase in operating expenses, and accounted for 130 basis points of operating expense de-leverage. When excluding Q2 2017 insurance proceeds and the presentation changes from the adoption of Rev Rec in Q2 2018, SG&A as a percentage of sales was about flat for the quarter. As Art mentioned, driving SG&A leverage through expense control and reduction continues to be a significant focus for the company, and we have made good progress. If you look over the last several years, our SG&A has been de-leveraging approximately 170 basis points per year. Excluding the presentation changes from Rev Rec, our first-half SG&A leverage 10 basis points, and we continue to expect modest to no de-leverage for the year. This demonstrates the power of the work we are doing on productivity. At the end of 2017, we established a dedicated internal team reporting directly to Art with the mission of identifying and driving against opportunities to reduce waste, drive efficiencies, and leverage scale. At the start of 2018, we set an internal goal to identify and action $200 million in productivity savings, marking a key step in our goal to deliver $500 million in savings. I am pleased to report we are on track to exceed that goal. Savings to-date have been enabled by things like strategic sourcing negotiation with vendors to deliver lower non-product costs, and beginning to optimize the organizational structures at headquarters, Gap brand and Banana Republic, by reducing our non-working marketing dollars focusing on in-store waste and inefficiency, and of course tighter controls over discretionary spending. We are pleased with the initial progress we have made to realize what I refer to as the low-hanging fruit, or where we have opportunities to be just a bit more coordinated across functions, or frankly just smarter about where we spend. Let me give you a couple of tangible examples that were covered through the work of our dedicated internal productivity team. In the areas of waste, we were throwing away significant amounts of excess in-store marketing content due to overproduction and misaligned store data. In process, we see opportunities to leverage system tools and automation in place as intended, versus some of our legacy processes that tend to be highly manual. And in scale, we have more opportunities to consolidate our product by the cross-markets and seasons to avoid minimum order penalties from vendors. As we move pass the low-hanging fruit, we continue to pursue opportunities to better leverage scale between brands, improve our product operating model, drive increased automation of work and processes, and eliminate non-value added work. These savings can fund our investments in the digital and customer areas that will further differentiate us and support growth. Now, moving on to taxes and interest, our net interest expense was lower, driven primarily by increased investment income as we move to better optimize our yield on excess cash. Our second quarter effective tax rate was 23.5%. The lower rate for the quarter reflects the deferral of certain fiscal year 2017 income that benefits from the tax rate reduction of the TCGA. We continue to analyze our tax return positions under the Act and will finalize our fiscal year 2017 tax returns during fiscal year 2018. Resulting adjustments to our provisional amounts may continue to impact our second-half rates. At this time, we continue to expect a full-year effective tax rate of about 26%. In earnings, second quarter earnings per share came in largely as expected at $0.76, compared to earnings per share of $0.68 last year. And that includes a $0.10 benefit from insurance proceeds. When excluding the benefit from a lower tax rate, we saw a $0.04 increase in earnings per share when compared to EPS last year, which is 7% growth. In line with expectations, FX was a benefit of about $0.02 for the quarter. On cash flow, year-to-date, our free cash flow was $220 million, $15 million lower than the first-half of fiscal 2017, which included $59 million of insurance proceeds related to property and equipment. We ended the quarter with $1.6 billion of cash, cash equivalents, and short-term investments. Consistent with our commitment to returning cash to shareholders, we completed an additional $100 million of share repurchases during the quarter, and we ended the quarter with 385 million shares outstanding. Year-to-date dividends of $188 million currently yields prior year dividend yield of about 3%. Inventory, we ended the quarter with inventory of 7% compared to the second quarter of 2017. Well, this is a point of time measure it's worth noting that about two points of the increase can be attributed to the calendar shift resulting from the 53rd week last year. Old Navy, which represents about half of our inventory, is entering Q3 with higher inventories in anticipation of plant store opening, but they are clean from a LIBOR perspective. Banana and Athleta also are largely in line with expectation, and we feel comfortable with the quality. We do continue to have some work to do on Gap brand given some of the assortment issues Art discussed. Inventory is up about 2% there, as we work to sell-through some of basics. Again, we made the conscious decision to hold this a bit longer given the warmer weather and the opportunity to enhance margin versus the quicker sell-off. Regarding capital and store counts, year-to-date, capital expenses were $326 million. Year-to-date, we have opened 60 company-operated stores, largely Old Navy and Athleta, by closing 38 stores, primarily Gap and Banana Republic. We ended the quarter with 3,187 company-operated stores. And now for the earnings outlook for the reminder of the year, as we have mentioned, at Gap brand, we are making the sequential progress we expected, albeit not as quickly as we might have liked. Neil and the team are very focused on implementing the operational discipline to return the brand to stronger profitability and growth. As we work through the remainder of the inventory issues, we are focused on solutions that maximize margin dollars. The fall season represents improvement as it is the first season, where we can narrow the assortment and begin to get inventory flows aligned. While not perfect, it should reflect improvement over the first-half with continued improvement through holiday. We believe we have appropriate building blocks on the remainder of the year, and although Gap brand is coming in at the lower end of our planning expectations, we have been able to leverage our productivity efforts and the strength of our other brands to deliver the first-half largely in-line with expectations. Additionally, as Art talked through, we have many customers digital and store initiatives that are building momentum and we expect that to accelerate in the back-half. Further, we have opened 37 new Athleta and Old Navy stores to year-to-date with plans to double that number in the back-half. As such, we are re-affirming our full-year earnings per share guidance range of $2.55 to $2.70 per share. As we mentioned in Q1, our ability to reach the high-end of the range will be more challenging given the trends we just discussed at Gap brand. And as a reminder, after adjusting for the presentation changes from Rev Rec, we expect spread to be flat to up slightly for the year. Keeping in mind, spread will be negative in the fourth quarter with the loss of the 53rd week. We continue to expect SG&A as a percentage of net sales to be about flat for the year as our productivity efforts fund our digital and customer investments. To be bit more helpful regarding cadence, we do expect modest de-leverage in the third quarter, and meaningful leverage in the fourth quarter as we left some unique incremental spend in the fourth quarter of last year that we do not expect to anniversary. And one final reminder, our spread and SG&A guidance holds and looking at year-over-year compares on a like-for-like basis, with and without the presentation changes of Rev Rec. So just to summarize, the quarter landed largely as we expected. We have more work to do, but we do remain confident in the appropriateness of our priorities as guided by the balanced growth strategy with continued focus on improving our executional excellence, leveraging our scaled operating platform, and exploring the power of our data assets. So with that, we will open it up for questions.

Thank you. [Operator Instructions] And we will take our first question today from Mark Altschwager from Robert W. Baird.

Good afternoon. Starting out just regarding Gap brand, it sounds like some lingering problems, but the worst probably past. So bigger picture, as we think about the margin delta between Gap brand and the rest of the organization, what's the reasonable goal in terms of the pace of margin improvement over the next 12 to 18 months? And then, separately, Teri just to clarify real quick, I apologize if I just missed this, but regarding the comp sales spread, can you clarify, was there a calendar shift benefit this quarter as you pulled over that back-to-school week? I mean if you could quantify that, that would be great. Thank you so much. Teri List-Stoll: Yes. So the second question first, so I don't forget that you have asked, there was no significant impact in the quarter from the shift. And part of that of course is because the back-to-school season is really lengthening out, it's less impactful in any given week as it may have once been. Broader question on the Gap brand margin is obviously a very fair one, you heard us mentioned a number of times on the call that we are very focused on getting through these inventory units, getting back to normal on inventory as quickly as we can, but in the first quarter we actually sold through some inventory because we knew it was right to get through it. This quarter we made a more different conscious decision because of the composition of the inventory, and the weather to hold that inventory a little longer to be able to optimize margins. So every single thing the team does is with that margin progression goal in mind. And we do -- now, if we think about where we are this year, I honestly do believe we have the opportunity to make very significant advancements in our margin over the next 12 to 18 months. I mean that is goal to regain some of the lost profitability that we have experienced in such a short period of time.

Thanks for the color, and best of luck.

And we will take our next question from Matthew Boss from JPMorgan.

Great, thanks. Art, I guess beneath the surface on your core Gap performance, I guess maybe any color on how comps progress by month in the quarter, maybe any learnings from back-to-school, and I guess if you think a positive comp is possible by year-end at this concept?

Matt, I always admire your persistence. And I think those are all reasonable questions. We are not going to break it out, I think we have been pretty clear here saying that we expect to see sequential improvement here as to whether a positive comp is possible. Anything is possible, but I am not going to call it right now. As Teri said, we are focused first and foremost on getting through the units that we have in the business with maximum yield. I know that we took a boatload of styles in CCs out of the business as we got into Q3. And we continue to balance the assortment as we get into Q4. So we are looking for that sequential improvement. And we are hopeful that it comes back fast, but I am not going to -- I just can't sit here and try to call an exact number for you.

Great. And then, just a follow-up, Teri, on the SG&A front, I guess as we think about the investments to drive top line versus the productivity savings, is there a comp that we can think about as the best to leverage SG&A on a multi-year basis, just in terms of a fixed cost hurdle? Teri List-Stoll: And looking at Tina, I don't think we have provided that metric, and it's sort of I don't have any color I can provide at the moment, Matt, sorry, but we are really -- I mean, as you can see, the reversal of the de-leverage that we have been experiencing historically is quite dramatic, and we do expect to be able to maintain that through the back-half of the year.

Great. Best of luck. Teri List-Stoll: Thanks.

[Operator Instructions] And we will take our question from Dana Telsey from Telsey Advisory Group.

Good afternoon, everyone. As you think about the Old Navy business and the $10 billion sales target now expanding into plus sizes, how do you see the classification opportunity in getting into that $10 billion? And the remodel store performance that you have seen in Old Navy how is that tracking and how do you see the progression of store remodels? Thank you.

Thanks, Dana, I appreciate it. If I think about the progression, and we have said this I think pretty consistently is the good news about continuing to drive growth in Old Navy is that it's very diversified, and we have confidence in that diversification. It's diversified across categories. So if you just look where we are seeing strength over the last quarter, knits and woven tops, big category, outerwear and sweaters, denim, woven bottoms, mens, knits and wovens, denim, woven bottoms, you see that strength in those categories and those are foundational loyalty categories, and it makes us feel really good about that strength. We have added plus to it. We have been looking at plus. We think the plus base is the big opportunity. We have not built big number, to be honest, four plus into achieving that $10 billion goal. And then we are continuing to obviously build stores which have exceeded our expectations. And the remodel program, as I said, is driving a five point comps spread. So those are dollars that I can spend all day long to continue to remodel stores. We have a pretty aggressive plan. We have -- I think the number is something on the order of -- several 100 stores at least, that are what we call the Old Old Navy which are oftentimes where we do a light touch remodel, which is really not structural. What it is paint and lighting and where we do the cash wrap, so it super efficient from a cost per square foot standpoint. And those remodels are performing just as well as when we go and do a full gut structural remodel and put in our new P3 concept. So I think we have a tiger by the tail in the remodel program in terms of really driving tangible sales improvements, and most importantly, obviously giving the customer a respectful refreshed experience that they are really engaging on.

Thank you.

And then I would remiss not to say the online business, because I think we have said Old Navy has the lowest penetration of online. We are looking at, and feeling like how do we continue to accelerate our online growth rate? We feel really good about the work that we are doing, and there is a reason that we launched BOPS inside of Old Navy first, because we drive that business, and we drive big numbers. So we are really super excited about the integration of the digital into the physical, and the fact that really one plus one, is we believe is way more than two as those businesses come together and create converged experiences.

Thank you.

We will take our next question from Randy Konik from Jefferies.

Yes, thanks a lot. I guess, Art, when you look at the traffic indicators that you presented in the PowerPoint, and Gap and Banana are lagging the industry average, how do you think about long-term positioning of these businesses? It seems like the market keeps thinking Gap Inc. is Gap yet the company is really Old Navy. So how do you think about kind of almost the position of how much real estate should be dedicated to those businesses? You have obviously worked on already communicating to us taking down store counts there, but what does it say about the long-term? And it's also really interesting that Old Navy has the lowest Internet penetration continues to be very strong, and shows no sign of slowing. So I was just curious how you are going to think about this all kind of melt together or you can separate the power of Old Navy and Athleta and kind of pull more of the exposure to Gap and Banana?

Yes. So let me just do a little bit of maybe correcting a misconception on the traffic. So if I look over the last four quarters, back to Q3 2017, to the most recent quarter, and I go by brand and by quarter, the only two quarters, where we did not beat industry traffic in two brands. So if you think about that as a metrics of 12 dots, there are only two that are red relative to the other. So we got a very good run, and I believe we can continue that run. And largely it is due to the many things that I have talked about, right, it's the bringing the digital and physical together, targeting our marketing, really put in place performance marketing capabilities, where we are targeting our marketing and increasing the effectiveness for acquisition, retention, and activation, pivoting the great majority of our dollars into digital channels versus traditional marketing. And then the focus that we have in stores through our rewards program, loyalty program, and customer information, we are building and we have positive momentum in building our customer file. And that is paying off in our traffic. So I don't view the -- I think that maybe overall, the industry is going to see negative traffic. I don't view it as an inevitable in any way, shape or form that we have go in the direction that the industry is going, because we have ample evidence that we can consistently beat the industry traffic trends. Now that said, the balance growth strategy is about managing a portfolio and allocating our resources and our investment both OpEx and CapEx to where we believe there is growth and continuing to reduce our exposure in places where we believe there isn't growth. And we have been doing that through obviously very aggressive store closures. And it's been most impactful in Gap in the specialty channel. We have not been impacting largely the outlet business in either Banana or Gap, because we believe those continue to be attractive businesses to be in. And then we are continuing to invest in online, because it is above average profitability as we have showed, and we believe there is long-term significant growth there. So I mean, Matt, I am glad you asked it, because the essence of the balanced growth strategy is to continue to focus our energies and invest in those businesses as well as reduce our exposure where we believe there is a downtrend at the end of the day. Now, I will say, just as a sidebar that I believe Banana has growth that nobody really appreciates, because Banana plays as a specialty brand, as a specialty brand relative to the department stores and relative to the premium contemporary lines out there that are largely department store distributed. And what we see as taking market share or frankly losing market share as we did, it is largely against those competitors, and I think we have a good share opportunity right now, it's not like the entire department store sector is driving at the moment.

Can I ask one follow-up then? Art Peck.: You got it.

Yes, sorry. If you then look at -- it's very helpful, one thing that really stands out is if we kind of go back to when the company disclosed the segment profitability by division, I guess we could have seen probably that the Old Navy margins have probably increased since then, but yet the Gap division margins have likely probably decreased. So really why Gap -- no pun intended of maybe 1,500 basis points, it's hard for me to tell between Gap and Old Navy at this point, I am just trying to figure out how you think about you positioning the business of Gap either from a real estate perspective or as you said, OpEx, what can be done to kind of just really get a little bit of that profit back and those margins back up?

Yes. I mean there is number of things, as you could imagine the equation, and let me point out that just the highest -- shareholder value is delivered tomorrow by beating expectations. And we believe we can, and we will see it, the sequential improvement in the business. If you go through the P&L, it's the things that you would expect, which is we do believe we owed some margin back in the business. And as we get the inventories in line and the assortment balance, we expect to see that. We are obviously taking out and we will continue to take out unproductive real estate, which has an impact on ROD. We do believe there is an opportunity in the overall cost structure of the business as well. And then, importantly again, back to the idea of managing the portfolio is we are aggressively managing the channel shift and the mix of that business from specialty and continuing into outlet and online, and we have already told you that the outlet business -- I'm sorry; the online business is growing at a rate that is significantly greater than the rest of the industry. And so, it's a combination and there is more to it than that, but what I would tell you is I have been super pleased with Neil, as Neil is very thoughtful and very methodical about how he sees the waterfall and the P&L and where we have opportunity whether as to margin or cost in order to get some of that probability back. Teri List-Stoll: And Randy, if I could just add, you are exactly right that since we disclosed margins last fall, there has been a shift, and we have been mixing into the healthier margins of Old Navy, Athleta. I wouldn't downplay the benefit of Banana on a rebound as well, which we do look at, and our objective as managers of the portfolio is to rewrite those contributions, so that Gap is going back to a more representative contributor to the portfolio earnings than it is today. But it is great to have the engines of growth we do have in Old Navy, Athleta, and the rebound in Banana at this particular time, and the productivity effort really just gives us some additional cushion to be able to continue to drive earnings progress in the face of this challenge, and knowing that we got upside from where we sit on the Gap brand given a lot more contribution today.

Just underlying the whole balanced growth strategy is about managing the portfolio and the mix of the portfolio to continue to pivot where there is profitability and attractive return on invested capital.

Very helpful. Thank you, guys.

Thanks, Randy.

And we will take our next question from Lorraine Hutchinson from Bank of America Merrill Lynch.

Thank you. Good afternoon. I wanted to follow-up on the Gap inventory. You talked about the word, "Imbalances" on the product assortment. And so, I guess I was just curious what we would see in the stores, how you expect to work those out, and if you expect to see continued sequential merch margin improvement in 4Q even on top of the very difficult comparisons?

Yes. So let me just provide a little bit more granularity on the inventory, because it's little easy to get twisted up than I suspect. So, first of all, we have carried some inventory that we felt was seasonally quite saleable over, rather than liquidated at a sort of an artificial threshold. And we believe that we are not encumbered with liability, but we have saleable merchandise, and we can work our way through. So that's part of the issue. If I look at the assortment imbalance, it's really not about the level of inventory largely, because we did bring levels down, it is about using our responsive capabilities, what we were able to cut in a relatively short period of time. And different products run different cycles, and as a consequence, the imbalance that we are referring to is really about having not the proper tops to bottoms ratio in the business that we feel we should have, we should be about 3 to 1, and we are lower than that. So the short-term implication of that is maybe a little bit harder to complete an outfit, but it's not crippling by any stretch of the imagination, but it isn't ideal in terms of where we want to be. We have solid inventory in our bottoms business. We have solid inventory in our kids and baby business. But if you think about the architecture of the assortment is, tops to bottoms, your outerwear business, your wovens business, and how they all relate to each other, we are not quite in the place where we should be from the standpoint of the composition of the mix. And we are confident again that, that gets better as we get obviously through the back-half of the year and in the spring of next year. We did feel that to maximize margin, it was the right thing to do to really tighten up CCs and programs. And so, we took that action frankly knowing that we're going to be looking a little bit imbalanced, but still believing that was the right thing to do. And Teri, I don't know if you want to jump in on the part of that… Teri List-Stoll: Yes, I would just confirm, Lorraine, that we do expect to see sequential progress, and even against the Q4 compare, we would expect to be able to have positive compares there as well.

Thank you.

We will take our next question from Chethan Mallela from Barclays.

Good afternoon, I wanted to follow upon a comment in the prepared remarks about the benefit of online sales that involved your store because of the enhanced profitability. Is there a way to frame how much of the $3.5 billion of online sales this year you expect to involve your physical store? And how you are thinking about the relative growth rates of online only or digital and physical going forward? And if you could give on high level, just frame the magnitude of profit differential. That would be helpful as well. Thanks.

Yes. So let me try to way through this, and I will let you know if Teri kicks me out of the table here. So I think we've been reasonably forthright in saying on an ongoing basis that our online business we have traditionally and historically run, and pretty consistently run with a margin advantage above the line. And a lot of that has to do with the inventory dynamics of one pool of inventory, you don't have stranded inventory. You can price more dynamically and that kind of thing. And that above the line advantage on merch margin has more than compensated for the incremental fulfillment cost below the line. And so, if you think about it in what the advantages that we've showed before relative profitability without going -- because I don't think we have released the specifics on the margin differences and the channels, merch margin differences.

This is Tina. We did with our presentation -- layout channel profitability and growth.

Yes. So it's probably best to refer back to that as to get an indication of the direction. And so, it's why we've always said, and we continue to believe that the volume that we continue to generate in our digital business can and will be accretive as it has been. On how much of that, so then you go through how much does a package cost below the line to fulfill, that's money that we don't have to spend and that will be, that's flow-through. The magnitude, it's just too soon to tell quite honestly. We've looked at analogs across other industry segments where they've turned on BOPS. And you can see penetration in ranges from 20% of your online business going that way to 50%. It depends on the category. I'm just not good, and it's even hazard to guess right now. We are very early days; we only turned on the marketing for BOPS, which you'll see if you engage on the Old Navy Web site. We only turned it on in the last couple of weeks. I would say all indicators are that this is something that she loves. But in no way, shape or form, have we really found out what the level of the lake is going to settle out at the end of the day. The other thing that's exciting here is the opportunity to build a basket when she comes into the stores. And again, in early days, we are finding that 20% of our customers on average are buying incrementally when they come into the stores. And so, if you think about the quality of that traffic, the opportunity to build the basket, the incremental profitability, it's something I think that has a long-term big potential for us, but it's again it's just very early days.

Great, thanks so much.

We will take our next question from Kimberly Greenberger from Morgan Stanley.

Great, thank you so much. My question is on Gap brand, Art, and I wanted to just ask if you and Neil have any sort of initial diagnosis of what's wrong and what's the likely fix here at Gap brand? And just looking over the last decade, it looks like Gap division has had more years of negative comps and positive comps. So, is there something more endemic there that you think is making that path a little bit more choppy? And then just a clarification, Teri, on the gross margin, I think you said that the 70 basis points of merchandise margin decline was driven by Gap, but then you talked earlier about trading comps for margin dollars with Gap brand. So I guess I'm not really sure how I can reconcile those comments that seem to be slightly contradictory, anything you could help us would be great. Thank you. Teri List-Stoll: And Kimberly, maybe I'll just close that out quickly. So I mean I think it implies what you're probably presuming, which is that the fact that we've worked to optimize margin doesn't mean we have made it positive, right, we continue to have pressure. Without those choices it could have been worse than it is.

And then on the deeper question, I don't think I'm slow and I don't think I'm stupid, and so I've been asking this question very much, because I'm pretty relentlessly objective and I want to love Gap brand, but I also want to be objective around whether there is something more wrong there than execution. And so, actually to that effect, I felt like it was super important to understand what the health of the brand was with this transition with Neil coming in. And we worked with an outside firm, bought apparel there with about 13,000 consumers, where we did a quantitative evaluation of the functional and the emotional equities of the brand. And we found that the emotional equities are actually quite strong that we have some issues on functional equities, where in one case, we might have customer perception of quality issue or fit consistency issue or that kind of thing. That actually was encouraging to me because I believe that functional equities are easier to address than the emotional equities of the brand. And so again, I'm not saying this is easy at the end of the day, but I just want to communicate here that Teri and I, along with the Board quite honestly are relentlessly objective around this business, both what we need to do and what its role in the portfolio is as we look at the performance of the business relative to creating shareholder value. And so there's no dilutions, no emotional attachment. We do believe we have an opportunity to claw back some of the profits that were deserved here, but we're also objective about the business and about the potential of the business.

Thank you.

And we'll take our last question from the line of Oliver Chen from Cowen and Company.

Hi, thank you. Art, regarding Gap brand and the operating discipline, it is out there and I know you do some innovative technology in terms of test read and react to customer trends. How can those principles be applied to Gap? And as you think about a lot of the tools you have with data science and customer lifetime value, what do you see happening with those products in the back-half? Any areas you could highlight? Has that seems like a very powerful and differentiated competitive advantage just to understand existing versus new customer and lifetime value and analysis? Thank you.

Yes. I mean let me take the customer one first, and I'll be sort of little simple about because I can go way deep on this one. But again, I've highlighted our data assets, it's a data asset that we just -- we're really just scratching the surface, we're just starting to explore. Individual leads or data sciences team we're building that team up pretty aggressively. But really for the first time in the history of the company, we do have a 360 longitudinal view of the customer. And we know that customer's psychographics and demographics. We know how they do or don't crush off our brands. We know the -- and are learning the sort of gateway product purchases for our brands that result in continued engagement. And the exciting part of that is more than interesting facts, it's -- and then we're able to target through digital channels pretty surgically look-alike customer segments that may not be engaged with the brand that show the characteristics of our best customers. And that is a very different approach to marketing, and I suspect most people in this industry have followed and certainly that's been our history at the end of the day. It is very aligned with what you would think about new economy company doing with respect to separating marketing out into performance marketing versus brand marketing. And that's very much how we're thinking about it going forward. So it is behind, the continued building of our file and the continued positive traffic that we're looking at. And then, Oliver, I know you had asked the first question, why don't you repeat it again, because I'm not quite sure I understood it, and I want to make sure I'm getting my answer right.

The framework around the operating discipline opportunities at the Gap division and what principles at Old Navy are important going forward in terms of those being kind of the framework for thinking about recovery opportunity for improvement at Gap? And I imagine…

Yes, and I'm…

- aspects of test [indiscernible] are important.

Yes, and we are very much using that, and I think again, Mark and the work of the team at BR have been largely built on the Old Navy framework, and it's why I think we are seeing a nice balance, and why I have a lot of confidence in terms of what they can continue to deliver. First and foremost, we noted at the beginning of the year we had receipt timing issues. And we are on that. Again, we said that's going to get better quarter-over-quarter-over-quarter, as unacceptable and it's not going to continue. That is really just operating discipline, and it had to do with a new tool that we have been introducing. We have largely worked our way through that. Customer respond is super important. I just had my Board of Directors with Old Navy last week, and we showed them some of the test and response and capabilities we have and how much of the assortment is being tested. And there is a clear line of sight between testing and product performance, margin performance, sell-throughs and APS. And we are bringing those tools into back into Gap as quickly as we possibly can. The other good thing I would say is that this is not we hired Neil and then we threw him in and come tell us when you are turning the business around. Neil is tightly integrated with the other three brand Presidents to make sure that we are leveraging the work that's working in the other brands as quickly as we possibly can, and we have transferred some on a short-term basis and some on a long-term basis talent into that business from other parts of the company. It's one of the most effective ways to cross-ref capabilities is to bring in some key players and to see them into the organization. So I can go a lot more, and we don't have time for it right now, but there are clear principles here, and it's brought the business some problems at the moment, because we did not adhere to those, we let the assortment architectures slip, et cetera, but the path forward in terms of what we need to do and how we need to do it I think is very clear.

Thank you. Best regards.

Thank you. And that does conclude our conference. You may now disconnect.