Good afternoon, ladies and gentlemen. My name is Jenny, and I will be your conference operator today. At this time, I would like to welcome everyone to the Gap, Inc. First Quarter 2020 Conference Call. [Operator Instructions] I would now like to introduce your host, Tina Romani, Head of Investor Relations.

Good afternoon, everyone. Welcome to Gap, Inc.'s first quarter 2020 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 non-GAAP financial measures, as noted on Page 2 of the slide supplementing our remarks. Please refer to today's earnings press release as well as our current report on Form 8-K filed on April 23, 2020 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 June 4, 2020, and we assume no obligation to publicly update or revise our forward-looking statements. Joining me on the call today are President and CEO, Sonia Syngal; and Executive Vice President and CFO, Katrina O'Connell. As mentioned, we will be using slides to supplement our remarks, which you can view by going to the Investors Section of gapinc.com. With that, I'd like to turn the call over to Sonia.

Thank you, Tina, and good afternoon, everyone. I hope you're joining us today in good health and that you're taking care during these challenging times. Before we jump into the results of our first quarter, I would be remiss to not address the situation that is top of mind for everyone across the United States with people of all backgrounds and beliefs coming together to drive social change. As a company, we have an opportunity to create a world that is more inclusive, ensuring our brand serve as a force for good by being open to all, listening and giving back to our community. While many peaceful protests have taken place across the country, in some cities, our stores have been taken advantage of and 20 stores have sustained extensive damage. We're fortunate that all of our teams are safe and we are working to reopen the impacted stores quickly and safely so we can serve our customers again. Now, turning to Q1. As I transitioned into the CEO role, we were making good progress with momentum entering the quarter led by Old Navy and Athleta, only to be met almost immediately with a shelter-in-place orders that resulted in the closure of all of our North American stores. As we monitor the situation in China and then Europe, we moved quickly to respond to the looming spread of the virus across geographies, its implications on our business and the industry. While there's no playbook to manage the fallout, the situation required a radical shift in our priorities. Starting first and foremost with protecting the health and safety of our employees and customers. While our online business continued to thrive, the store closure resulted in approximately 75% of our demand being disrupted. To help mitigate these impacts, we took swift action…

Thank you, Sonia, and good afternoon, everyone. As Sonia mentioned, while the first two months as CFO has certainly been unique, I've been both impressed and energized by how the organization has responded to this unprecedented crisis. I'd like to echo Sonia in thanking our teams for their tremendous work, an unwavering dedication to operating the business during an extraordinarily challenging period. It's at a time like this that I am truly grateful to be a part of an organization like Gap, Inc. As we continue to build toward our longer term growth opportunities, our near-term priorities in navigating the crisis are clear. First, strengthening our financial foundation to ensure sufficient liquidity and financial flexibility to navigate the evolving landscape and emerge positioned to gain share. Second, leveraging our distinct competitive advantages, a collection of $1 billion plus brands, highly engaged customer base, a nimble supply chain and an advantaged omnichannel platform. And third, thoughtfully preparing for the future as we will emerge one of the winners by pursuing a balanced approach to driving profitable growth by investing in capabilities that amplify our advantages, while streamlining our operations and repositioning our fleet. As the crisis hit, we pivoted to the first and most important priority, preserving cash and accessing liquidity to provide us the flexibility to navigate our worst case scenario for this tumultuous year. In response, we did the following. We deferred our previously declared first quarter dividend, suspended dividends and share repurchases for the remainder of the fiscal year, cut capital expenditures in half to recession level lows, furloughed a majority of store employees, implemented temporary executive and board pay cuts, reduced expenses across all aspects of the organization, including a 15% headcount reduction, worked with our vendors to move from 45 days to 60-day to 90-day payment…

Thank you, Katrina. So you've heard from both of us and you know that we are focused on refashioning this company for growth. As we know that the retail landscape is changing rapidly and will undoubtedly look different in the future. From the competitive set to how customer shop for us with our products and engage with our brands. This is a really unique moment. The industry and everything is changing and we intend to lead that change by being a progressive leader in this transformation. We will do this by deeply listening to our customers and working alongside our partners and other industry leaders, to set the course for the next 50 years on the back of our last 50 years of a strong, growing company. We believe our brands will be poised to take share based on momentum we're seeing with stores reopening and a sustained online acceleration, coupled with our dominant market position and growing categories, I'm excited by Gap, Inc.'s ability to win. And so, with that, we will open it to Q&A.

Thank you. [Operator Instructions] And we will go first to Dana Telsey of Telsey Group.

Hi. Good afternoon, everyone, and hope everyone is safe and healthy. As you think about the complexion of the business on the margin side and the attributes going into it, whether it's rent, whether it's wages, what kind of differential do you need going forward in order to operate the business, smaller and stronger and what are you looking for in rents besides abatements? Is there cotenancies? Or what do you think the occupancy structure needs to be? Thank you.

Thanks, Dana. It's Katrina. And I appreciate you asking the question. As we think about rents, I think as I said in my remarks, we still believe that a small healthy fleet with good rent economics is incredibly important to our business model as we look to maximize both our strongly located fleet combined with our strong omnichannel and e-commerce – our omnichannel capabilities and e-commerce platform. That said, we do have some stores that need to be renegotiated from a rent structure standpoint. And so, that's where we are today is using this unique opportunity to go back in and leverage, as you say, whether it's co-tenancy abilities to renegotiate lease terms or whether it's just partnering with our landlords in these acute time to try and get some rent relief in our long-term structure so that we end up with a portfolio of stores that we think meet our profitability objectives. We haven't put a number out there. We're deep in those negotiations right now, but we do look forward to emerging from this with a profitable fleet that we think well complements our online business.

So let me just add to that, too, Katrina. We're pleased with the progress we've made with hundreds of landlords as we're reopening across the country as the right progressive partners are recognizing as we do that the world has changed. And that means that our customers have changed. And so, we want to create a mutually beneficial win-win structures with our rents and that's what we're seeing happen with our partners, which is quite good.

Got it. Just a quick follow-up on inventory. As you think about inventory by brand or by channel and the pack-and-hold that you have, how much of it is pack-and-hold? And have you ever had pack-and-hold levels like this before?

So, we're not quantifying the pack-and-hold. I will say, we've not had levels of pack-and-hold like this before. We feel quite good that the pack-and-hold consists of either ongoing basics or summer product that was not ever delivered to stores that we can keep on hand. We can either access it to deliver to stores or we can hold that and assort it into next year. And so, I think we feel quite good about the pack-and-hold. I'm not sure, Dana, if you can remind me the balance of your question?

And in terms of the inventory levels, how you think about inventories throughout the year? And does it differ by brand? Is Gap the brand that's the most over-inventoried as you'd like – from what you'd like to see?

No. I wouldn't say that at all. I think all of the brands have been very prudent in managing their inventory and we've taken care of the spring inventory glut that we had through the inventory impairment that we told you about today and we feel quite good as we think about inventory for the back half. As we – as the crisis hit, we were able to impact our back half inventory levels to lower demand and we're using our responsive capabilities to chase into the categories that are working and the brands that are working and fundamentally, as we've said, we're seeing good traction, particularly at Old Navy, where we have lots of flexibility to get back into demand.

Thank you.

And we'll go next to Mark Altschwager of Baird.

Good afternoon. Thanks for taking my question. So clearly a lot of important items on the agenda right now and I have to imagine certain items on your transformation agenda were put on hold during the crisis as well. Others, perhaps like store closures, were maybe accelerated. So, my question is, what do you think is a reasonable timeline to get from where the business is today to the optimal operating structure and store footprint of the future? Sonia, I think you talked about refashioning the company. I guess the question is, do you think the company could be refashioned by 2021, or is this more likely a 2022 story? Thanks.

Yes. Mark, it's a question, and I'll let Sonia add anything. We're not yet guiding to what we think the exit rate on store closures will look like. But we still do feel like we will make good progress, similar to the progress we had put out at the beginning of the year as far as Gap brand closure. So that work is all largely on track. That said, because of the current environment, we're actually using this opportunity to talk through really virtually almost every property and lease with every landlord to see if we can get after whether it's rent, the lease term or whether we would actually just close the store. So, we're just knee-deep with all the landlords today. It's very hard to say how long it will take, but do know that it is one of our primary objectives is to use this opportunity to partner with our landlords to come out with a better profitability for the company.

Yes. Let me just add that – some thoughts on that. Thanks, Katrina. One of the things, as we studied past crises, and we have done that deeply, the most important thing on strategy is not to set the strategy too early. It's to stay flexible and to very clearly and acutely listen to what is happening, what our customers are doing, and that's what we're intending – that's where we intend to operate right now. What we know is our omni capabilities, stores, online working together is critical for us and we know that we will be invested in that capability holistically, that ecosystem around the customer, that fuel our powerful brands. And 60 million customers and growing with growing frequency, it's an enviable customer file that we intend to capitalize on. Those are really the top three assets we see, our powerful brands, our customer file and our omni capabilities. Those three together, enabled through our lean operations and our values, which values matter today more than ever are going to be the elements that shape and refashion this company and how that plays out. I don't know that we're ever done on that front. It's an evolution. It's a daily work to move toward those aspects.

Thank you. That's helpful. And if I could just ask a quick follow-up on digital, it looks like trends accelerated nicely in April and into May. Just any color on the various drivers there? Whether it's pent-up demand, stimulus or some of the markdown activity? And what do you think is a reasonable expectation for kind of a normalized digital run rate in the months ahead?

Listen, I think that if we could offer the customer, it would be a great thing. But what I will say is this, we – as soon as we turned our shift from store and as we started to fully activate and lean into our online business we saw sequential week-over-week, month-over-month growth. And how that normalizes as our stores fully open is something we're actively looking at. We do expect being such a large e-com business, $4 billion last year, and that's significantly growing, that gives us advantage in share of voice out there in the marketplace against smaller players that we fully intend to capitalize on.

Great. Thanks for all the detail and best of luck.

And we'll hear next from Matthew Boss of J.P. Morgan.

Great, thanks. Maybe to dig a little deeper into recent trends, what level of productivity are your Old Navy stores in particular reopening at relative to that 70% total company metric that you gave? And then maybe just on the 100% e-commerce growth in May, what are you seeing at Old Navy and Athleta relative to the Gap brand?

Yes. Those are great questions. So, as it relates to productivity, I think it's fair to say that Old Navy, given the strength of the brand, as well as the fact that Old Navy is positioned in off-mall locations where the customer is likely more confident shopping, as well as the curbside pickup capability is easier to activate, we're seeing a meaningfully better trend in productivity at our Old Navy stores. As you can imagine stores that are in malls are harder to get people to shop at. And so, you would imagine that maybe Gap and Banana are lower productivity, that averages out at that 70% – about 70% mark that we're out today. But it's early days, we are just in the process of reopening. We're pleased to be at 1,600 stores today open, but that's 55% of our fleet. And so, we have a ways to go. And then as it relates to online, I would say, similarly, whether it's Old Navy, who has the advantage of being a family brand servicing kids and baby, as well as in the value space, you can imagine that seeing strong trends. And then Athleta with strong brand health and the athleisure trends being so strong is also seeing great performance. But I think we're also pleased that we – Sonia can potentially talk about it, we made some changes at Gap brand and we are seeing some meaningful improvement in our Gap brand online business as well.

Yes. Gap brand's online strength has built and we're quite happy with it. We don't break it up separately, but we're quite happy with it for May. And as you know, Gap has been a challenge for us and we're focused on five elements there really the first is leveraging our online growth; the second is store fleet rationalization; third is rightsizing our resources with the 25% headcount reduction, I mentioned; the fourth is new products and segments like Gap team; and the fifth is cost-effective, our asset-light opportunities like the IMG licensing. We think this coupled with proven leaders in place in design merchandising and online are going to fuel this business as we rightsize it and build it for health.

Great. And then maybe just to follow-up on gross margin, what are you seeing broadly from a pricing and promotion standpoint on reopening in the mall? Maybe just help us to think about mark downs in the second quarter versus back half of the year as you see it right now?

Yes. I mean, interestingly, it seems as though, I don't know. But it feels like a lot of people got many of the inventory issues behind them. And so, while there will be promotions in the second quarter, I'm not sure that they will be meaningfully different than the first quarter. I think the commentary we put into our script was just to ensure that the fact that we are growing our online business so high in the second quarter, but that the inventory is being serviced from stores, we did nod to the fact that we do have an unusual amount of fulfillment costs to consider, but beyond that, from a promotional environment, largely the same likely.

Great. Best of luck.

And we'll hear next from Kimberly Greenberger, Morgan Stanley.

Great. Thank you so much. I wanted to just follow-up on the productivity of stores as they're reopening. Are you seeing any geographical variance as you're opening in terms of the productivity of the new stores across the United States? Are you seeing any sort of differences? And then maybe if you could talk about globally what you're seeing, that would be helpful as well?

We've seen – I'll start with global, since the pandemic hit China first, as we – we've seen a nice recovery in our China business month-over-month, and the omni business there now is really pivoting toward managing in a more normalized fashion as we look into Q2, which is nice to see. As Japan's reopen, we've seen a better than expected rebound in our stores demand and pent-up demand. And then as our stores have opened across the U.S., really the factor of a combination of the few things, one is real estate type, the second is weather, the third is consumer sentiment as it relates to safety. And so, we've seen some early on good performance in the south and the west with the weather signaling the need for summer clothing. East and the Northeast in particular is little bit lagging. And yet, we expect that as those stores open up and as the consumer wants the seasonal shift and as kids grow and need clothes that's all – that's going to play out.

Great. Thanks so much. And I just wanted to follow up, Sonia, with your – the sort of vision you laid out with regard to the responsive capabilities that you have built and continue to build in your supply chain. And I wanted to ask, if you could sort of wave a magic wand and get to your destination on how much inventory you would be ordering upfront on more standard kind of lead times versus what percentage of inventory you ultimately expect to be able to use that responsive capability for? Is it like a 70-30 split or if you could just help us understand what the end goal looks like? And then where are you now? What sort of that split now? Thank you so much.

Yeah. Thank you for the question. The inventory is complicated space right now, especially as we try to match supply/demand across our multiple brands. But what I will say is this; we have really leaned into accelerating our responsive expectations in each of our products – in each of our brands and moving as fast as we can to – faster and more quicker order placements so that we are agile in matching those two in terms of matching supply and demand. And as quickly as we went after masks, it's the great example of our fast and responsive supply chain across all of our brands, when we saw that as both a need for healthcare workers and as a customer need, we activated our responsive supply chain very, very quickly. So, I think we are pleased with the acceleration that we're seeing. As far as the end state, like I said earlier, I'm not sure there is an end state. We want faster and faster and more and more responsive and that's what we will be aiming for.

Thank you.

And we will go next to Jay Sole, UBS.

Thank you so much. And so, my question is, does the consumer gets acclimated to all the great deals that they're seeing out there? How do you think fiscal 2021 will look in terms of your ability to return to normal pricing that you're used to and get the gross margin back, specifically the merchandise margin back to where it was in fiscal 2019? Thank you.

Yeah. Thanks, Jay. I mean, I think as Sonia said, we believe we have a lot of assets as they relate to strong brands, as it relates to very strong and growing customer base that we intend to speak to, not through pricing and promotion as much as through experience, brand stories, loyalty, the other things we have in our arsenal to be able to drive our business. And so, I don't think we're as concerned about the long-term promotional aspect of the business and expect that – It seems like so far the consumer is snapping back fairly quickly. And so, really our role is in continuing to drive healthy brands with great capabilities and the appropriate ways to be speaking to that consumer about why to shop with us more frequently as we look to drive lifetime value with those customers. So I don't think we're as concerned about the promotional environment, but we'll see how it plays out.

Got it. And then maybe can you also just talk about SG&A in the second quarter, because in the first quarter you called that $484 million? If we take that out, plus the actions that you took, you've already talked about it quite a bit. Can you give us a color – give us an idea of how much SG&A will be down in Q2 relative to where it was ex the one-time items in Q1?

Yes. So we're not quantifying that. I think in the speech we tried to give you some of the puts and takes, right? We've made some pretty meaningful decisions around headquarters reductions and we quantified that for you. We also are closely monitoring marketing, but we haven't quantified. We've been pivoting our marketing expense from store traffic driving marketing into digital marketing. And so, we've been cutting as appropriate, but also ensuring that we're driving our digital channels. So we're watching that prudently and certainly, by brand it will differ, but we're looking at marketing closely. And then the other big line item is stores expenses. And as we reopen stores, we will see expenses coming back into the business. And as we said, those are likely to be a little higher. We are all being very careful about metering and extra people at the doors and in the sitting rooms. And, in fact, we're getting great customer response from them feeling safe shopping in our stores, but that will result in higher operating expenses. So there's lots of puts and takes and we'll see how the quarter plays out. But what we have said sort of more broadly is, we understand in this uncertain time that we are committed to really watching every dollar of SG&A to ensure that we are prudently investing in growth, but also being careful as we watch the uncertain environment play out.

And I would just add that one of the things we did – one of the things I did in terms of organizational structure, as I stepped into the role, the first week, in fact, is, we structured the leadership team and the priorities against some of these priorities that I've talked about, powerful brand, focus on customer, and omni capabilities and then the lean and mean operations that are going to be essential to continuously managing down SG&A. So we have consolidated many of our large operation to – and stood up a value office in order to continuously improve on the SG&A front. And while the quarters might be lumpy, we're setting a new standard and expectation around SG&A as we move forward with this company.

Got it. Thank you so much.

And we'll hear next from Paul Lejuez of Citi.

Hey. Thanks, guys. I'm curious if you could talk about Gap and Banana, and the stores that have been reopened. Any big differences that you're seeing between outlets and closed malls, street locations? Also, one follow-up on the pack-and-hold, is that across brands? Just curious if that's kind of in proportion with the percent of sales that each brand represents. Sorry if I missed that. And then, just curious on the $484 million charge, how many stores did that touch? Thanks.

Thanks, Paul. So, as it relates to the store reopenings for Gap and Banana Republic, as you can imagine, similar to the Old Navy discussion, the outlet and the outdoor malls are performing better than indoor malls. Your second question, I'm not remembering but your third question, we haven't quantified the number of stores that are related to the store asset impairment. So, it's just the number that we've given you, not the number of stores.

Yeah. The second question was pack-and-hold across brands.

Yes. Sorry. And so, as it relates to pack-and-hold, it's different by brand, it's not proportional to brand. And honestly, it's just – it's hard to quantify by brand, because it's sort of moving around, as you can imagine, as demands unfold, we could go use the pack-and-hold. So, we haven't quantified it by brand.

Okay. Thank you. Good luck.

And we'll move to our next question from Kate Fitzsimons of RBC Capital Markets.

Yes, hi. Thanks very much for taking my question. I guess, Sonia, you had alluded to earlier, approaching, I believe, Gap brand into the back half with more narrow and deeper assortment. Just kind of curious how you are thinking about the merchandise strategy, ideas or flashes of newness that maybe we could potentially see into the back half just maybe to reengage the customer? And then just as we approach back to school, denim is obviously a very important category for you guys. Just how are you thinking about the denim business approaching that for the back half, just given some of the category commentary we've heard here in Q1 about an emphasis on lounge and casual, et cetera?

Yes. Thank you. So, Mark Breitbard is leading the brand is hands on actively looking at all those opportunities around the merchandise direction. I know he believe that Gap stands for modern American optimism and focusing on the core items that the brand's all been famous for, as you say, playing into the kids and baby business, the denim business, those essentials that are modern and available and American and classic. Those are the aspects that will shape the assortment. And the assortment is going to get more and more focused and deeper. And so, that is the strategic direction. And the specifics, we'll follow up and I know Mark will share more at the right time.

Great. And just on denim, just higher level views on the category?

We think we're well poised to drive denim share across the company. And we're one of the largest players. And so, as it relates to denim and Gap, I think that it's a very important category for the brand and will continue to have an important role.

And that will conclude the question-and-answer session. I'll turn the call back to our presenters.

Thank you. You can disconnect.

And thank you. That does conclude our conference. We would like to thank everyone for your participation. You may now disconnect.