Good afternoon, ladies and gentlemen. My name is Dede, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Gap, Inc. first quarter 2016 conference call. [Operator Instructions] I'd now like to introduce your host, Jack Calandra, Senior Vice President of Corporate Finance and Investor Relations.

Good afternoon, everyone. Welcome to Gap, Inc.'s first quarter 2016 earnings conference call. Before we begin, I'd like to remind you that the information made available on this webcast and conference call contains forward-looking statements. For information on factors that could cause our actual results to differ materially from the forward-looking statements as well as reconciliations and descriptions of non-GAAP financial measures, please refer to today's earnings press release as well as our most recent Annual Report on Form 10-K and our subsequent filings with the SEC, all of which are available on gapinc.com. These forward-looking statements are based on information as of May 19, 2016, and we assume no obligation to publicly update or revise our forward-looking statements. Joining me on the call today are CEO, Art Peck; and Executive Vice President and CFO, Sabrina Simmons. Sabrina will be using slides to supplement her remarks, which you can view by going to the Investors section at gapinc.com. With that, I'd like to turn the call over to Art.

Thanks, Jack. I appreciate it. I want to spend some time on where we are and where the industry is strategically and what we are doing. You'll recall that over a year ago, I spoke to you very directly about the fact that we were not where we needed to be in terms of products, across our brands, and how we needed to bring product to market. And we have done a great deal of work across the company over the last 12 months-plus to be focused on product, focused on restoring the aesthetic of our brands, quality where is appropriate, consistent fit and a number of elements of product, including building responsive product capabilities. I am pleased with the work, it is the right work and we will scale this work progressively period-over-period as we go forward. But clearly, we need to do more, faster. And so with that, we've announced several other things that we're going to be taking on with a high degree of urgency. This is an environment that we're operating in today that demands faster change. We are present today with our global footprint, where apparel dollars are being spent. That said, that is never meant that we will compete in every geography, with every brand and every channel. And I'm a strong believer in this company of trying things, learning from them, making adjustments and moving forward, and doing that with speed and doing that decisively. As part of this, we have announced that we will be winding down our Old Navy operations in Japan, partly due to the macro factors in that environment and partly due to, frankly, needing to apply the resources to greater and higher potential opportunities. I am obviously disappointed that we're going to be discontinuing operations, but I view…

Thank you, Art. Good afternoon, everyone. As you heard from Art, we're committed to focusing the business to gain market share in key strategic markets, where we believe we are structurally advantaged and/or where there is significant runway for growth. The decisions we disclose today will allow us to better align our talent and financial resources against our most important priorities. First, we've made the decision to wind down our Old Navy business in Japan by the end of fiscal 2016. Additionally, we are planning to close a number of dilutive Banana Republic stores, primarily internationally. Further, we are taking steps to streamline our operating model. Let me give you some detail. Regarding, Old Navy. As a reminder, we launched Old Navy Japan in 2012 and have 53 stores. While Japan will continue to be an important market for the company with over 200 Gap and Banana Republic specialty and outlet stores remaining, the investment in terms of both financial and human capital to build a new brand in that market is significant. Given the lack of growth in the apparel market there, we have decided this level of investment wasn't prudent. In the near term, Old Navy's growth ambitions will be anchored in North America, including our newest market, Mexico, as well as China and the franchise business. These opportunities present significant potential for us. With regard to streamlining our operating model, we have an opportunity to become more nimble and better leverage our scale. This will allow us to deliver the continued expense discipline you have come to expect from us and mitigate the natural upward momentum in SG&A. Together, we expect these decisions to result in annualized savings of about $275 million and operating margin improvement of nearly 2 percentage points. It's important to note that we…

That concludes our prepared remarks. We will now open up the call for questions. We'd appreciate limiting your questions to one per person.

[Operator Instructions] Our first question will come from Simeon Siegel with Nomura Securities.

Can you share any more color on the specifics behind streamlining the operating model? And then, Sabrina, maybe any help on the timing of when you'd expect the cost savings to hit?

I mean, most of the savings are going to come from the operating model actually. But I would tell you that the actions are going to take place throughout 2016. So we don't expect a significant portion of the annualized number to come in '16. Although, it is going to be helpful, and as I said, it's going to enable us to deliver the continued expense discipline that you'd expect from us.

And then, if I can just follow-up on that. In light of the comments on the full year guide, do you think anything is changed in the ability to forecast the business longer-term? And is there any changes in the predictability in general? And if so, is there anything you can do to maintain your ability to plan the business going forward?

Look, I think what was really interesting about Q1 was really based, in our assumption, around traffic, which we had never expected positive traffic, but we didn't expect deeply negative traffic. And the other interesting thing about the trend was it was quite erratic. So we know that February started quite well, and even March started quite well and it fell off precipitously in the week before Easter. So I think we just want to talk for a minute and see if the Q1 volatility is a continuing trend or an aberration for us. And that will allow us to get a better sense of the full year and the assumptions we want to base that on. But as I said, I think that the consensus estimate is very reasonable in terms of the range of outcomes that we could predict at this time.

And next we'll hear from Matthew Boss with JPMorgan.

Could you just talk to your promotional strategy today? I guess any changes to potentially drive increased traffic in the second half and any consideration to potentially taking a cut to initial ticket prices just to maybe reset the bar? And then, last question, just regarding distribution. I know you made some comments about Amazon. Just any opportunity in sort of the thought process between the potential partnership at some point?

Sure. Let me try to address all of those. Several of those bundled together, that was very clever. If we just think about promotion, I think it depends on the brand, because we're in very different positions on each brand. Gap and Banana having come out of situations where they were extremely deep over the course of the last, in some cases, 18 to 24 months, because of big product issues. And in both of those businesses we are working to drive topline, but also to tighten up our discounts. And if you are a subscriber to our emails or in our stores or on our website, you'll notice that it is real, it is not easy, but we are working in terms of the depth of promotions, the promotional frequency and the breadth they cover. And I actually was just with the Gap team, where we went through looking at our commercial plan up to Memorial Day, and how we're trying to drive very compelling seasonally appropriate message from a promotional standpoint, so that we can play, but also working to protect margin as much as we can. Same is really true on Banana, where we have backed off. And I will be the first to say that when you start tightening up in promotion, you are playing a game of chicken with your customers, and they try to way you out. And so we've been playing that now for really the last quarter. And we've seen more effects on this quite honestly. It will be easier in Gap, where we're seeing the numbers move more consistently in the right direction, a little more sporadic inside of Banana. Maybe we have been promotional. We are promotional. We missed execution in Q1 from a marketing standpoint, and we are really…

Our next question is from Dorothy Lakner with Topeka Capital Markets.

I wondered if we could go back to product for a minute, and Art, if you could talk about just the evolution that you're trying to affect at Old Navy where you had too much fashion and you need to adjust the mix, how long you expect that to take? And then, at Banana, where you may have assumed that the better product would get a better customer response and it didn't, what you're doing there? And then lastly, how we should see the evolving mix at Gap, since you are seeing success, both topline and margin, how we should see that evolve over the course of this year?

Yes. Let's talk Old Navy. Old Navy really started to soften for us in Q4. And that was right around the time, as you recall, we also had a leadership departure, and an interim leader. We got in there very quickly. We looked and diagnosed the problem by then Q1 was bought, so we had the assortment architecture that we had. And again, the issue there is not as much less about product acceptance and much more about the architecture, the assortment, and frankly, duplicative and over assortment largely in the women's business, items that were bought for very short fashion buys, a collections orientation, and we lacked the depth and tightness around key items buys in Old Navy. And so on diagnosing that, that's obviously come through Q1. As we have said before, focused on making changes as quickly as possible in Q2, which was coming at us pretty quickly, and I feel much better where we are in Q3 in the reset of the assortment architecture. I don't want to leave unmentioned the fact that we have not had strong marketing in the first quarter of the year. And that has contributed to what has been an unacceptably soft Old Navy business, when I believed value continues to remain strong. And so it's deeply disappointing to me. We pulled TV out of April. We had ineffective TV. TV is a big brand driver for Old Navy and we're back on that as we look into Q2, and then certainly into Q3, and line up for back-to-school. And so I'm not going to call everything right, as we crossover the threshold into Q3, but I'm confident that we have the proper diagnosis, we took the proper actions, we've realigned the commercial plan, and the overall macro trends for a…

And our next question is from Paul Trussell with Deutsche Bank.

Just wanted to inquire about maybe inventory goals. I know it's a volatile marketplace. It's tough to know the pace of trend that you'll be dealing with. But just how should we think about what would be a comfortable level of inventory for you guys by the end of maybe 2Q or yearend?

As I said, we're guiding to a low-single digit negative for Q2 and we just finished Q1 at a minus 3, so similar trend. We have said all along especially for our North America specialty brands, we want to keep the inventory pretty tight. Now the tightrope we all walk is you don't want to bring it down so far that you cut off your opportunity to get a positive comp, so that is always the delicate balance that we walk, but we think pitching it where we're pitching it right now at a low-single digit negative strikes that balance, so that's what we're looking for.

Let's go to Paul Lejuez with Citi.

It Jennifer on for Paul. Quick question on Athleta. I was wondering if you could talk a little more about that, give us a sense of the size of the business now and maybe the margin structure of that business.

We don't disclose a lot about that yet, Jennifer, but you can get a sense from it in our other column. So included in the other column is Piperlime, INTERMIX and Athleta. And Piperlime, we wound down in Q1 of last year, so the number looks a little bit funny because of the lack of Piperlime sales this year when we had them last year. If you remove that, we'd have a double-digit increase in other and that gives you a sense directionally since Athleta is much larger than INTERMIX. That gives you a sense directionally of that business.

Well, can you give us a sense of size of INTERMIX and how that's performing really?

Well, I think the way to think about that Jennifer is we haven't grown the fleet very much, since we purchased it. And so I think back then we probably gave a sense of the size of the purchase, so its kind of been trying to tighten up and learn about the business model, so there hasn't been much growth there, so I would say the primary driver of the growth in that column is going to be Athleta.

And then did you say how much FX impacted earnings this quarter?

Yes, we did in the press release, but I'll tell you now again that its 4 percentage point drag on earnings per share in the quarter. Thanks for asking because I didn't say it in my remarks.

And next we'll hear from Ike Boruchow with Wells Fargo.

Sabrina, could you maybe give us a sense of the timing, I'm sorry if I missed it, but the timing of those roughly 75 store closures, maybe what quarter those will fall into? And then just to clarify, so those stores represent about $250 million in sales and generate a loss of $275 million or is there something else like back office or headcount that gets you to $275 million in savings?

So let me take the last part of that first. So the $275 million, I guess, is made up mostly of operating model changes we are making across the Board at Gap Inc., so the Old Navy Japan contribute to the $275 million, that is not the majority at all. So the majority is the streamlining of our operations across the board. With regard to the store closure timing, I would expect that to take place throughout 2016 and really probably weighted towards the end of the year.

Next we have Brian Tunick with Royal Bank of Canada.

I guess, Sabrina, I was curious, I think you mentioned either 2 points or 200 basis points of an operating margin benefit go forward. I wonder if you're referring to 2017, if you're referring to the core business or does that have to do with some of the streamlining you're doing, that you're announcing today. So just curious about what you thought? Does that mean your longer term operating margins can get back into the low-double digits over the next couple of years? And then second question, on Old Navy, sorry to beat it to death again, but just wondering between macro and weather, I mean how much could this fashion miss or over-fashion really have impacted the quarter here. It seems like it a couple of months now the trend has been decelerating, so just wondering as you parse out different buckets what you've learned and what's the timeframe again you'll see those product changes?

So I'll start on operating margin, so the base that we're talking off of is sort of our expected 2016 base, so if you remove the sale of $250 million and you remove all the associated line items that gets you the annualized savings of about $275 million, Brian, you get about nearly 2 percentage points of operating margin accretion. So it's actually quite powerful from an operating margin perspective. So we're very pleased with that. This is going to be a journey back. So this is a big step forward in focusing us on the businesses that have the highest potential for long-term profitability and removing those that have quite a dilutive impact. So that's on the operating margin. I'll turn it over to Art for the second question.

Sorry, the second question was around Old Navy, correct, and product. Again, like I said earlier, we saw what we saw in Q4 and gone immediately. And again, that was coincident with the change in management and leadership transition. We made modest changes to Q1, as we previously indicated, because most of that product was either here or on the way. So could have a limited amount of impact. And then incremental changes in Q2, as well, and the ability to significantly affect Q3, and obviously wholly affect Q4 And so from the standpoint of the assortment architecture, which again was really largely around women's product being over assorted and lacking in the appropriate variety across some of the key programs and then lacking the inventory depth behind key buys that is significantly corrected as we get into Q3. At the same time we've had weaker marketing against some strong marketing that we've had in the previous year and we work to correct that. We put TV and the number of other things back into the schedule in order to bring our boys back everyday. And so do I believe that we're going to continue to see weakness in the business on a going forward consistently? I don't, because the value proposition again is in the sweet spot, where we should playing right now. I have much more confidence that the architecture of the assortment is back in line in Q3. And then Q4, I think we're in a very good shape and we have a very strong marketing program decked against it.

And next from the Telsey Advisory Group we're here from Dana Telsey.

As you think about the opportunities and the focus on supply chain, logistics, CRM, with each business what's the opportunity and what's the timeframe to achieve that? Do you think it help sales or helps margins?

Dana, that's a question we can probably spend a day talking about, so I thank you for asking it. Surely, you're aware obviously since we have spend a lot of time talking about the backend that we're doing, the backend work we're doing on supply chain, and that's work, that is again, a journey not a destination. I'd see significant scaling of that as we go forward in the businesses period-over-period. But it's again, a journey that we're on at the end of day. If I look at some of the other areas, let's go to CRM first for a second. It's what I am really passionate about, I just announced a position in the company of a Chief Customer Officer, where we are taking a wide variety of desperate connections that we have with our customer and stitching them together organizationally and beginning to really build the capability to have a much more consistent, deep and holistic view of our customers as individuals. In core of that, as you might imagine, is our credit card, which are our best customers. It's a program that we only have in the United States, which is part of why I go to structural strength. It's a very strong program here for us in the United States and it represents a significant portion of our business. And I'm not of a mind that an organizational change brings about meaningful change, but we have had bits and pieces of the customer, again, in the number of places in the company and I've just broken those walls down and brought it together. And if I think about where best practices are broadly, we are well behind that. I think we're actually in a pretty good space from where best practices are in the apparel industry…

And we have time for one final question from Omar Saad with Evercore ISI.

I would love to hear a bit of thoughts on ecommerce side of the business. It's such a strong suite for you guys for so many years. I know it sounds like you're kind of moving a little bit more towards investing behind the mobile capabilities to round out the suite of your prowess there. But could you give us an update on kind of how you're thinking about ecommerce business? And then maybe how we should expect the mobile side of it to pulled in over time?

I think it's really a question to place where we have had strength and we continue to have strength. And we see it obviously as everybody does, I think, a long-term progressive shift of the consumer moving in that direction. Let me go straight to mobile for a second, but let me do the, sort of, what I call the leaky bucket. If you think about business moving from stores to a desktop or laptop to mobile, stores for the industry, conversion of traffic into stores, whether its in the mid-20s to the high-30s or something like that; if you go down to a desktop or a laptop experience, where someone is buying, that traffic converts somewhere in the low-single digits for most people out there. And then if you go to a mobile experience a lot of people out there today are seeing conversion off of mobile traffic as a fractional single-digit. And so the work that we're doing is very much about addressing that migration of traffic and making sure that the opportunity for us to monetize that traffic as it moves remains there at the end of the day. So if I go straight to mobile, a big part of mobile is making sure that people have an incredibly easy shopping experience and checkout experience on the mobile device, but the content is relevant, so that needs a responsive website, which we're largely towards achieving right now. And then, obviously, content and the digital experience that shows up on a screen that's 2.5x5 inches at the end of the day, and so that's something where we're very focused for us. Overall, our traffic has grown and it's grown with digital. If I were a retailer out there, who was looking at this and was seeing my traffic being directly substituted from my stores to a desktop to a laptop to a mobile device, I would really start to worry about that bucket leaking out the of the business. And so we're committed to making sure where our customer is. And our customer today increasingly is on a mobile device, which means a great mobile shopping brand and ecommerce experience. End of Q&A

I'd like to thank everyone for joining us on the call today. As a reminder, the press release, which is available on gapinc.com, contains a full recap of our first quarter results as well as the forward-looking guidance included in our prepared remarks. As always, the Investor Relations team will be available after the call for further questions. Thank you.

And that does conclude today's conference call. We thank you for joining.