Good afternoon, ladies and gentlemen. My name is Cody, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Gap Inc Fourth Quarter 2019 Conference Call. [Operator Instructions] I would now like to introduce your host, Ms. Tina Romani, Head of Investor Relations. Please go ahead.

Good afternoon, everyone. Welcome to Gap Inc.'s fourth quarter 2019 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 reconciliation of the non-GAAP financial measures as noted on Page 2 of the slide supplementing Teri's remarks, please refer to today's earnings press release as well as our most recent annual report on Form 10-K and our subsequent filings with the SEC, all of which are available on gapinc.com. These forward-looking statements are based on information as of March 12, 2020, and we assume no obligation to publicly update or revise our forward-looking statements. Joining me on the call today are Interim President and CEO, Robert Fisher; Executive Vice President and CFO, Teri List-Stoll; and incoming President and CEO, Sonia Syngal. As mentioned, we will be using slides to supplement our 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 Bob.

Thank you, Tina, and thanks everyone for joining us on the call. Today, you'll hear from Teri, who takes us through the quarter as usual, and then I've asked Sonia, our newly announced an incoming CEO, to join and share a few thoughts before we open up the line for Q&A. Before we jump in on the numbers, I want to say a few words about why the Board and I are so confident in our choice of Sonia as the next leader of this great company. I've had the opportunity to work with Sonia over her 16-year tenure with the Company, and even more closely this past year. Sonia led Old Navy from $7 billion to $8 billion in sales between 2016 and 2019, expanding its North American presence to over 1,200 stores in the U.S., Canada and Mexico, scaling its e-commerce site to the Number 4 largest apparel site in the U.S. and building competitive omni-channel capabilities. She also drove the evolution of the Company's product to market model, and I've watched her lead organizations across the portfolio: our international business, supply chain, and most recently, Old Navy with vision, conviction, and a constant eye on the needs of our customer. Sonia has a deep understanding of what drives performance and productivity, always focused on continuous improvement. This is why she is the right leader for this organization at this transformative time. She's a passionate leader focused on moving fast, while driving a culture of accountability and alignment. What I really admire about her is that she leads with both vision and heart. Additionally, she brings a wealth of institutional knowledge and the skills and experiences to best lead this Company during this time. Sonia is someone who can hit the ground running, and she already has. In addition to our Q4 earnings, we also announced key members of Sonia's new leadership team. As part of that, Katrina O'Connell, who most recently served as CFO and SVP of Strategy and Innovation at Old Navy, will step into the Gap Inc. CFO seat. I've personally known Katrina for 25 years. This is a very deserving and important announcement. Teri will stay with the Company for the next few months to ensure a smooth transition, and I'd like to thank her for her many contributions to our company over the past few years and for her steady, clear-eyed counsel and partnership. Finally, I want to acknowledge the challenges that coronavirus is creating for our customers, our employees, our business, and our analysts. I can't imagine what you all are going through right now, and I just wanted to acknowledge that. Teri and Sonia will add some detail around coronavirus, but please note that as a company, we're committed to protecting our people, the people who shop with us, and the employees who are the heart at Gap Inc. And with that, I'll turn it over to Teri.

Thanks Bob, and let me also thank you on behalf of our employees and the Board for the leadership and support over the past four months. This has been an important period of transition for the organization. With our decision to no longer pursue the separation, we were clear we would not revert to how we had operated in the past. With your leadership, we have begun that forward progress, providing more focus and accountability and being a champion of the imperatives for transformative change. With our announcement last week that Sonia will serve as Gap Inc.'s next CEO, the organization has more confidence that the path forward will continue to build on the changes being implemented and a strong sense of urgency in driving the transformation necessary for improved results and future growth. It's difficult to talk about the business without first acknowledging coronavirus. As most have noted, the situation remains highly fluid, and we are of course monitoring developments closely, while establishing global contingency plans for a range of potential scenarios. There are two important impacts to consider, demand suppression and supply chain disruption. It's early days to fully estimate the implications of either. Let me start with supply chain where we know a bit more. Over the last year, we've made meaningful progress against our migration away from China and currently source about 16% of our goods from China, down from 21% last year. However, we should note that a significant portion of fabric production occurs in mills operated in China supplying vendors outside of China. While early days, it appears that much of the mill production will remain largely on schedule. Additionally, we did not experience any meaningful disruption from factory closures in China at the start of this year. With regards to our broader global…

Thank you, Teri. It is truly an honor to lead this company that's built a rich heritage over the past 50 years. The opportunity for Gap Inc. to compete successfully in the years to come is the task at hand, and I look forward to paving the way together with the talented teams in our stores, distribution centers, offices around the world and supplier partners, some 130,000 strong. It goes without saying that the week following my announcement as CEO has been unique. Right now, like everyone else in the marketplace, we are facing a rapidly evolving climate based on the COVID-19 situation. We're leveraging learnings and business continuity planning that began with our Asia team. We will continue to assess and manage through disruption in real time, particularly in hotspots such as Washington and New York, as we see this unfold further in North America. While the full impact and the duration of the outbreak is unknown, we are better positioned than most in our space to navigate the uncertainty ahead. One, we had healthy free cash flow generation and nearly $1.7 billion of cash on hand at year-end. Two, we have a long-standing large-scale vendor relationship network that supports us. And three, we are well prepared to be prudent with the other levers of our business, including expense and inventory management, as well as capital spending. We've just come off completing a substantial body of work that began as we prepared for the separation, which will enable us to accelerate cost transformation. We're entering the year with the benefit of knowing this company better and more objectively than we ever have known. Culturally, we identified bureaucracy, complexity and misaligned incentives, and in some cases, lack of accountability. Across all facets of the organization, we now have a far…

[Operator Instructions] We'll take our first question from Paul Lejuez with Citigroup.

It's Ex Tracy Kogan filling in for Paul. I had a question about Athleta. The 5% comp that you guys posted for the year, I was wondering what the drivers of that were between traffic and ticket? And then also, as you look at fourth quarter, I know you had some issues with inventory but the drivers there of that 2% comp? Thank you.

Yes. So we - as I said in the script, we continue to see good strength in our bottoms franchise and also in the girls, which really were the key drivers of the business. The execution issues I talked about were really what caused a bit of a lag on what we see as the growth potential going forward in that brand. I don't have the specific traffic numbers in front of me, but we can follow up with you offline on that.

Sure. I guess, in general, has it been more of a traffic-driven comp or more of the ticket, even if you can't quantify?

Yes, we still see positive traffic trends in that [indiscernible]. That's one of the - we talked about the profitability of the stores and the continued strength of the brands. Yes, we definitely continue to see positive traffic as well as positivity.

We'll move on to our next question from Alex Walvis with Goldman Sachs.

I had a question on what you've been seeing in terms of U.S. trends. I know that it's very early to say that - you mentioned that you've already started to see a little bit of slowing in traffic. So, I wonder if you could elaborate on that. And then secondly and relatedly, perhaps you could also share some comments on what you've seen with respect to tourists in both the U.S. and in Europe to the extent that that may have been weak for a little bit longer enough.

Yes, you're exactly right, and it's very early days. And it's - every day this week, in fact, it's been sort of a multiplication of available information. We definitely have started to see some traffic impacts, as you say, started more in the tourist stores where that slowdown was felt. And then, more recently, we've started to see it in some of the hotspots you would expect, in the Northwest and the Northeast, particularly around the New York area. So we're watching it every day. We're putting in place contingency plans. I don't know, Sonia, if there's anything you want to add in terms of how you're thinking about the situation broadly.

Thanks Teri. One of the benefits we have is that we've been watching the impact of COVID-19 in Asia over the last nine weeks and more recently in Europe. And so, working with our Asia teams that have been at this, it has given us a head start in how we think and plan for the North America business. So, as some of these challenges have emerged in our South markets for tourism and in the Northwest and the New York as current hotspots, we feel prepared to move into action and are working hand-in-hand with all the right authorities to focus first and foremost on employee safety, business continuity, supply management, which is in good shape as Terry alluded to in the script, and now, demand management in North America.

In Europe, have you seen weakness concentrated in Italy or is there broader weakness across Europe? And what's embedded more specifically in the guide for Europe?

Yes. So, what we're seeing is the same thing we tend to expect will happen in the U.S., which is sort of waves through the geographies, and so - it started in Italy. But particularly as it becomes more of a global pandemic, the reaction that people have tends to precede and accelerate versus how it may have developed in China, which is one of the reasons it's so difficult for us to be able to fully extrapolate and estimate the impact as it continues this way. So what we've done for the first quarter, where we have a little more experience under our belt in those geographies, is done our best job of trying to estimate what it is for those geographies. But to your point, there's still a degree of uncertainty in [technical difficulty]- Europe. So we will keep you very much posted as we move through the quarter and get further into the year.

[Operator Instructions] We'll take our next question from Kimberly Greenberger with Morgan Stanley.

Kimberly?

Ms. Greenberger, are you on the line still?

We'll take the next question.

Thank you. We'll move on to Lorraine Hutchinson with Bank of America.

Could you elaborate a little bit more on what happened with Gap? That was a nicely positive merchandise margin story for a lot of last year, and it seems like you hit a little bit of a stumble in the fourth quarter. Maybe talk about what happened specifically. And how quickly you think you can fix that and get the margin stabilized there?

Yes. So, we continued to show some margin expansion in Q4. So the missteps really affected top line overall such that the overall profitability became challenged. And it really - it did come down to the - largely the items that I mentioned in my prepared remarks in that we had some marketing executional issues that were both with respect to the campaigns itself, but also some of the digital marketing execution, which affected traffic in the quarter. And we continued to struggle with product assortment, and as I said, sort of the clarity of the brand focus. And so, those are the things that Mark is very much digging into with a high degree of urgency. Sonia is spending time thinking through what the approach is to that brand. I think the thing we would all say - and we've been saying this for a little while is that we will be very objective in evaluating that brand and what we need from that brand to really earn its way in the portfolio. We continue to believe, given the missteps, that we haven't really tested the brand to understand what the possibility is there. But we have a high degree of urgency to address the profitability, and that is priority one for Mark supported by Sonia's view of the strategy going forward.

We'll take our next question from Susan Anderson with B. Riley FBR.

I was wondering if you could maybe elaborate a little bit on the Old Navy brand and what you see that you're doing different now that's driving the improved performance, I guess, particularly on the women's side. And then, I guess, on the Gap front, if you have any thoughts around how you're thinking about the strategy going forward in terms of product such as styling, quality, price, or any changes there? Thanks.

So, I can start with Old Navy. We're pleased with the signs of stabilization demonstrated in Q4 and confident with the sequential improvements we've seen quarter-to-date, really driven by our turnaround in our women's business and continuing to raise the game in our marketing efforts. So, that was fueled by a higher aspiration and clear big ideas as we moved into Q4, also enabled through the tightening of inventory and then excellent execution in our stores and our e-comm channel. So it's a combination of factors, certainly fueled by the turn of the women's business. And yet, we still have much work to do ahead. So we are laser focused on traffic as a priority. And all the signals in the business show that it's a lagging indicator for us but we'll catch up as the sales over traffic continues the momentum that it's seen. And then your question on Gap, the playbook for strong brands is clear. We know how to do this. We've done this for Old Navy with the clarity of the democracy of style and executing flawlessly at every touch point with the customer against that North Star. We've done this with the Power of She in Athleta, and also that shows up with consistency. Ultimately, it begins with that brand clarity. And Mark is hard at work with the team in Gap brand, illuminating that clarity and bringing it to life across the entire business. Coupled with that, the operating discipline and the operational execution goes hand in hand. And that is what we're after. It's what we know how to do and have done in other parts of the Company. And we have a tremendous amount of urgency against moving forward with those - application of those learnings for a brand that is as ubiquitous as Gap. That being said, we're very clear-eyed about the trend in the business and will continue to act with - was an imperative and urgency around the progress.

We'll move on to our next question from Oliver Chen with Cowen and Company.

As we look at various scenarios in this unfolding situation, the topic of social distancing as a key healthcare strategy and what's happening, what are your thoughts if traffic decreases industrywide to low-double digits negative or worse? And also, as you think about a recessionary environment, if you could help brief us on fixed versus variable costs and different items within your control, that would be great. Thank you.

Yes. The good news going into the situation is that we have done some excellent work in preparation for the separation to understand all of our cost drivers, what we can attack and what we can go after. And so, with that work at hand and with the experience we've had in the last 2.5 months in Asia to understand consumer behavior and the cost levers we have to pull, we're moving swiftly into action, leaning into the productivity opportunity and the cost management opportunity, coupled with tight inventory control. That is what is going to enable us to navigate the uncertainty ahead. Again, we had healthy cash flow generation and we start with a very strong cash balance. So we feel well poised relative to many others to navigate what will be an uncertain and difficult environment.

The only thing, I guess, I would add to that, Sonia, of course is that in the social distancing context, we have such a large e-commerce business and we continue to invest in improving that customer experience. And I'm sure, as you go forward, that will be a key priority as well.

Yes, right. Our customers will have many avenues in which to purchase from us, and e-comm is certainly one of them. We also know that our stores are activating a high degree of safety measures linked to all the best advice that we've gotten from government health inputs.

And the last part of this is, as you work with more operators and have great relationships and partnerships there, what are your thoughts about what will happen to the mall and the health and safety of going to the mall and how that may impact your business?

Yes, obviously, it's hard to project exactly the course this will take. But I can imagine that our landlords in the mall, owners are doing the same things we are doing in terms of trying to ensure safe environment for their shoppers and to be able to create as much resiliency as they can in their business model to be able to ensure that they can sustain or rebuild traffic as necessary as we work our way through this.

We'll take our next question from Simeon Siegel with BMO Capital Markets.

This is Dan on for Simeon. Just wondering if you could give any color and quantification on where the brands are versus their historical levels for gross margin? Thank you.

I'm sorry, could you repeat the question?

Just looking for any color, any quantification on where the individual brands are versus their historical gross margin levels.

Versus their historical margin levels. Okay. I'm sorry, I didn't hear. What I would say is that we were pleased, certainly, with Old Navy, which obviously is where the focal point is, and we were pleased to see a lower promotional environment there for Old Navy, building off of the improvement in product that we've been seeing sequentially, and so - and then the tightening of inventory over the course of the year. So we did see some margin progress there. And as we look forward to the coming year, we would expect to continue to see improvement in the merchandise margin, as we continue to see that sequential progress. I definitely would acknowledge that the Old Navy operating margins are below their historical highs. I think, if you go back to a few years, in 2017, that was a particularly strong period of time, and not sure that should be the benchmark of the expectation. I think, across each of our brands, we will expect to continue to see margin progress as we invest in a lot of the capabilities we've talked about that should take waste out of the system and drive both financial margin but also efficiency at the SG&A line as well. So I would say, if you peg us today, we're not at historical highs, which we view as representing an opportunity for expansion going forward.

Thank you. And we'll take our last question from Kimberly Greenberger with Morgan Stanley.

It looks like we lost you again, Kimberly. So I think we're about up on time. So I think that's going to wrap up our call for today. Thank you for joining.

Thank you.

Thank you. That does conclude today's conference. Thank you all for your participation.