U.S. Markets close in 4 hrs 58 mins

Edited Transcript of GPS earnings conference call or presentation 28-Feb-19 10:00pm GMT

Q4 2018 Gap Inc Earnings Call

San Francisco Mar 6, 2019 (Thomson StreetEvents) -- Edited Transcript of Gap Inc earnings conference call or presentation Thursday, February 28, 2019 at 10:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Arthur Peck

The Gap, Inc. - President, CEO & Director

* Teri L. List-Stoll

The Gap, Inc. - Executive VP & CFO

* Tina Romani

The Gap, Inc. - Senior Director of IR

================================================================================

Conference Call Participants

================================================================================

* Adrienne Eugenia Yih-Tennant

Wolfe Research, LLC - MD and Senior Analyst Retailing, Department Stores & Specialty Softlines

* Alexandra E. Walvis

Goldman Sachs Group Inc., Research Division - Research Analyst

* Dana Lauren Telsey

Telsey Advisory Group LLC - CEO & Chief Research Officer

* Lorraine Corrine Maikis Hutchinson

BofA Merrill Lynch, Research Division - MD in Equity Research and Consumer Sector Head in Equity Research

* Mark R. Altschwager

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Matthew Robert Boss

JP Morgan Chase & Co, Research Division - MD and Senior Analyst

* Oliver Chen

Cowen and Company, LLC, Research Division - MD & Senior Equity Research Analyst

* Paul Lawrence Lejuez

Citigroup Inc, Research Division - MD and Senior Analyst

* Randal J. Konik

Jefferies LLC, Research Division - Equity Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good afternoon, ladies and gentlemen. My name is Melissa, and I'll be your conference operator today. At this time, I'd like to welcome everyone to The Gap, Inc. Fourth Quarter 2018 Conference Call. (Operator Instructions) I would now like to introduce your host, Tina Romani, Senior Director of Investor Relations. Please go ahead.

--------------------------------------------------------------------------------

Tina Romani, The Gap, Inc. - Senior Director of IR [2]

--------------------------------------------------------------------------------

Good afternoon, everyone. Welcome to Gap Inc.'s Fourth 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 reconciliation of the non-GAAP financial measures, as noted on Page 2 of the slide supplementing Teri's remarks, please refer to our earnings -- 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 February 28, 2019, 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.

With that, I'll turn it over to Art.

--------------------------------------------------------------------------------

Arthur Peck, The Gap, Inc. - President, CEO & Director [3]

--------------------------------------------------------------------------------

Hi, everybody, and thanks for joining us today. I'm going to start by discussing the announcement we made this afternoon to separate Gap Inc. into 2 independent publicly traded companies, cleverly named NewCo and Old Navy. I'll then get into specifics around the quarterly results.

Our announcement today is an acceleration of our balanced growth strategy and an indication of my commitment to position all of our brands for success. With this plan, we will stand up 2 independent companies, creating a unique and differentiated portfolio of specialty brands in NewCo and stand-alone Old Navy, both well-positioned to lead in the evolving retail landscape.

NewCo will bring Gap brand, Athleta, Banana Republic, Intermix and Hill City into one operating model. I feel strongly that this combination of brands will be powerful. By bringing them together, we can better leverage capabilities and investments across the brands, share best practices and drive efficiencies to create value for all stakeholders. NewCo will have approximately $9 billion in annual revenue, a strong balance sheet and a significant opportunity to innovate and explore new ways to serve the customer. And quite frankly, what's on my mind is to write the next chapter for specialty retail. I also believe NewCo will be positioned to take a global leadership role in sustainability. It's the ethos of this company and the ethos of these brands.

In Old Navy, we have one of the fastest-growing apparel retailers in the United States with a winning business model and an impressive runway for future growth, including capitalizing on opportunities like opening new stores and expanding into new product categories. The stand-alone company will have approximately $8 billion in annual revenue, and we'll be able to capitalize on its scale, broad consumer awareness and unique positioning to drive growth.

So why are we doing this? And why now? Our customers' preferences and shopping habits continue to evolve, which is challenging the traditional retail model. We've responded to this with our balanced growth strategy, which has positioned us well with investments in our global supply chain, our digital capabilities and an enhanced and evolving omni-channel customer experience, while, at the same time, improving operational efficiencies across the company. But over time, Old Navy's value creation levers, business model, and customers have increasingly diverged from our specialty brands. That divergence to me is now clear, and we think the best way for each company to grow and meet the evolving needs of our customers is to allow them to pursue tailored strategies separately. The separation presents us with a unique and catalyzing moment to simplify what we are doing and how we're doing it. With more-focused companies, decision making can be accelerated, and I'm confident that we'll be able to move quickly and with agility to serve our customers.

Let me describe what each of these companies is going to look like in a bit more detail, starting with NewCo. Following the separation, I will become the CEO of NewCo. I'm excited to lead and continue to lead these great brands under a different structure that will create clearer focus on what is necessary to deliver improved profitability in our mature brands, Gap, Banana and Intermix while capitalizing on the momentum in the newly launched Hill City. With approximately $9 billion in revenue, NewCo will continue to have scale but will be better positioned to drive sustainable growth, improved profitability by levering a scaled operating platform to deliver distinctive products and experiences to an attractive and loyal customer that significantly overlaps.

In NewCo, we have the advantage of iconic brands, but we also have a business that needs to evolve and change. With our concurrent announcement on restructuring the Gap brand specialty fleet, we have a smaller, healthier base of stores that provide a critical component of the omni-experience that our customers demand. In addition, we will continue to grow in the -- with the value trends in the industry in our outlet and factory business across the portfolio and thoughtfully evolve specialty access through locations and formats that serve our customers' shifting shopping patterns. The NewCo challenge and the NewCo opportunity is to provide truly frictionless access across stores and digital, to continue to harness the power of data from cross brand shoppers and to become, what I'd call, radically more responsive to our customers.

As I mentioned earlier, NewCo will be uniquely positioned to grow its leadership, also, in sustainability and social responsibility. It can build off the B Corp certification, recently earned by Athleta to potentially become the largest publicly traded B Corp, positively impacting the environment, our employees, our vendors and our customers. Responsibility has been a foundational element of Gap's history, and we have the opportunity and obligation to lead the industry going forward.

Turning to Old Navy, which I am, quite honestly, equally excited about. As the #2 apparel brand in the U.S., with approximately $8 billion in annual revenue, Old Navy will be able to capitalize on its scale, broad customer awareness and unique positioning to extend its category leadership, maximize revenue growth and deliver profitable growth as an independent company. Sonia Syngal, who has led Old Navy since 2016, will continue as the CEO of the stand-alone company. She has a proven track record of results, leading Old Navy's most recent transformation and driving product-to-market innovations that serve all of our brands. She also has deep experience managing and optimizing the supply chain and manufacturing both at Gap Inc. and in other industries.

With its U.S. store footprint underpenetrated versus the value peers, Old Navy will have improved focus and operating discipline that will enable it to increase customer access through new stores, including in-fill locations and smaller markets, where our tests indicate substantial opportunity. Old Navy will continue to evolve its omni-channel model and will have the opportunity to expand its product categories and market presence to continue to successfully resonate with value-focused consumers. I look forward to seeing where Sonia and the team take Old Navy. I and all Gap Inc. shareholders have a vested interest in that success.

Teri will discuss some specifics of the transaction in more detail, but before I hand it over to her, let me switch gears and hit some highlights of our Q4 and fiscal year results. Overall, the quarter did not live up to what I know our brands can deliver, and we did not finish the year as strongly as expected. As others have pointed out in the industry, the macro environment played a role. But we know we can do better, and we are committed to doing better in the areas of the business that we control. That said, as we look back on the year, there's many things to be pleased with. We made good progress on our productivity goals and disciplined choices to deliver our guidance. We saw the continued renewal of Banana Republic with positive trends and a stronger foundation. We continue to see market share gains at Athleta and Old Navy, and we made meaningful investments in technology to drive future growth and efficiency.

Before I dig into our fourth quarter performance of Old Navy, I think it's important to put into context the health of the brand, which remains strong and a market leader in the value space. And I just really want to start this conversation by saying I have 100% confidence in the Old Navy business and the Old Navy business model. 2018 was a record year for the brand, delivering comp growth of 3% or 9% on a 2-year stack. And the brand continues to operate at very healthy margin rates, leading The Gap, Inc. portfolio. Underlying this success was a large and healthy active file of high-value multichannel customers that grew double digits in 2018. The brand also nicely grew its high-value multichannel shopper base. Old Navy has successfully introduced new product to the assortment that have quickly become must-have staples, such as fleece, puffers and fashion outerwear. These add to the continued strength in tees and jeans for the entire family. Old Navy continues to play and win across a wide range of merchandise categories with continued room to grow.

Looking after the quarter and after -- looking -- sorry, looking at the quarter, after a strong start in November and through the Black Friday weekend, Old Navy, like other concepts, experienced deceleration in traffic in the middle of December, and we quickly began hindsighting the trend. While there may have been some macro issues at work, we also recognized we could've done more to engage with our customers to drive traffic during this typical lull in the season. We also acknowledge that our assortment did not provide enough newness or excitement and that our investments in products were more heavily skewed to repeated winners, leaving less room to flex into better-performing items. While we are generally not satisfied with our execution for the holiday and should've been able to drive a better Q4 result, we know, and I know, the brand's momentum remains solidly positive. Old Navy is still an incredibly exciting growth story, and I remain very confident in the brand health and the leadership team's continued focus on delivering exceptional product, fresh marketing, superior customer experiences and continuously pursuing operational excellence to drive growth.

Turning to Banana. Overall, 2018 was a year of progress that strengthens our confidence in the relevance and potential for Banana Republic with the brand achieving a positive comp, coupled with 120 basis points of product margin expansion in 2018.

On the product side, Banana Republic grew market share across pillar categories including sweaters, suiting and dresses and skirts. On the customer side, our connection with the customers at BR is getting even stronger, and our customer base continues to grow as product acceptance ticks up. Acquisition and reactivation rates improved over the last year, reflecting marketing that now has a more consistent and brand-appropriate aesthetic.

On the operations front, the team is now working more productively and efficiently from their single headquarters location in San Francisco. In Q4, BR delivered margin expansion, which was a continuation of their trend, underscoring the team's commitment to reducing the intensity of promotions used in the commercial plan. In line with this strategy, the brand pulled back on promotional levels during the quarter, which was a detriment to traffic and ultimately comp during the highly competitive holiday season. The team is continuing to assess the effectiveness of utilizing varying degrees of promotional messaging, particularly during event-driven periods such as holidays, as they continue to focus on providing value and experience our customers expect while continuing to drive margin expansion.

Overall, the BR team is determined to capitalize on the momentum seen throughout this year and will incorporate key learnings from holiday as they continue to focus on building strength through customer reengagement and acquisition, all the time while reducing promotional intensity to drive further margin expansion.

Athleta. Zooming out for the year, there's a lot for us to be proud about their performance, another market share gaining year. We opened 13 stores ending the year with 161 stores. The girls business remained spectacular, delivering an over 60 comp for the year. The entire company received B Corp certification, which is really resonating with customers and employees. The active customer file grew 20%, exceeding their goals. And we launched our men's performance lifestyle business, Hill City. In Q4, Athleta experienced similar traffic softness in December that we've spoken about. Although sales less traffic, a key indicator of product acceptance, remained positive and held to year-to-date trends. We continue to see tremendous market share opportunity and runway for growth in 2019 and beyond by leveraging the brand's differentiated positioning and purpose-driven mission, our unique range of product offering and growing our capabilities in performance, fabric innovation.

Moving on to Gap. As I committed last quarter, we have taken thoughtful and decisive action to radically restructure our fleet to address stores that are underperforming or do not represent the best of Gap brand. Teri will get into more detail, but looking ahead, we intend to close approximately 50% of our specialty stores. The majority of the closures will be concentrated in North America, leaving us with a smaller but healthier specialty fleet. While there's work to do on the remaining fleet, including continuing to reduce square footage and bringing stores to brand standards, we're confident these closures will play an important role in revitalizing the brand. After the closures, we expect to see significant improvement in channel mix, with our profitable online and outlet businesses representing approximately 2/3 of the business and specialty, the other 1/3, down from about 1/2 today.

As I mentioned last quarter, our market research strongly supports the view that Gap remains a relevant brand with strong emotional equities. As challenging as 2018 was, logo sales, which, to me, are an indication of the equity of the brand, were up 11% globally. To me, this is a clear sign of the relevance of the brand and, even more importantly, the strong emotional connection with and pride in a brand like Gap.

It's clear the potential for future growth and penetration is there. We just need to give our customers the quality, fit and style they want. And to address those issues, we've been focusing on improving the product engine of the business on 3 fronts.

Process improvement. As you know, we're adopting best practices from across the company while driving a culture of continuous improvement; talent and structure, super important and critical to me. Neil has been in the building now for about 6 months, and he's been investing in the right talent and structure for Gap brand.

Clear lines of accountability for our channels and regions, dedicated teams to give North American specialty an outlet. We recently announced the appointment of Alegra O'Hare as Chief Marketing Officer, formerly with adidas. Alegra is a marketing innovator with extensive experience leading a major brand through a creative turnaround and, frankly, a major brand through a revitalization, and we're thrilled to have her skills and her perspective on board.

And lastly, category strategy. Denim is the core of Gap brand, and we are and we will be leading with denim. We recognize the competition in the market for denim, but the market is large, and the market is attractive and is the essence of Gap brand.

The world we live in is divisive, and this really gets to the core of Gap brand's equities and the heart of the brand. We believe and our customers tell us there's something really special about what Gap brand can do to bridge the gap, by leveraging the strengths of our iconic brand to offer products and an experience that celebrates individuality, drives inclusion and brings us together. We have our work cut out for us, this we acknowledge. But we know what we need to do to win, and we are committed to restructuring the fleet and revitalizing Gap brand to unlock shareholder value and drive profitable growth.

As we've already outlined in this call, there are many opportunities to drive profitable growth in our amazing brands. I intend to continue to pursue those tirelessly and aggressively, both strengthen the results of Gap Inc. for 2019 and to set both NewCo and Old Navy up for success as independent companies.

This is somewhat of a historic moment for the company, one where we begin to chart the course in our 50th year for the next 50 years. We're creating 2 compelling companies that will have the ability to drive growth and value for customers, employees, shareholders for many years to come. We have a lot of work to do before the separation. We're just beginning the detailed planning to support the execution, and I will not allow this to distract us from delivering on the current business so that our brands enter their next phase healthy, strong and poised for growth.

With that, Teri, I'll turn it over to you.

--------------------------------------------------------------------------------

Teri L. List-Stoll, The Gap, Inc. - Executive VP & CFO [4]

--------------------------------------------------------------------------------

Thanks, Art, and good afternoon, everyone. In the interests of time, I'll be quite brief in my comments to leave time for Q&A, of which, I suspect there are a few. Let me start with some additional information on the separation announcement.

We expect that the separation will be effected through a spin-off to Gap Inc. shareholders that is intended to generally be tax-free for U.S. federal income tax purposes. Once the separation is complete, Gap Inc. shareholders will receive a pro rata distribution of the shares of NewCo and Old Navy stock. The ratio of shares that will be distributed will be determined prior to the actual separation. We currently expect the transaction to be completed in 2020, subject to certain conditions including final approval by Gap Inc.'s Board of Directors, receipt of a tax opinion from counsel, the filing and effectiveness of a registration statement with the U.S. Securities and Exchange Commission and certain other customary conditions. After the separation, NewCo and Old Navy are expected to be appropriately capitalized with sufficient liquidity to support both planned operating and investment plans as well as capital allocation philosophies.

It's early days in the execution planning process, so I'm sure you'll have a number of questions that we are not prepared to answer definitively at this point. As we move through the process towards separation, we're committed to full and transparent disclosure to ensure a complete understanding of the transaction and its implications.

This is an important and transformational step for Gap Inc., one that affects our employees, our investors, partners, vendors, other stakeholders and one that we certainly haven't taken lightly. It has become increasingly clear that our balanced growth strategy, while successful in building necessary capabilities in areas like supply chain and digital capability that are important to a scaled operating platform, no longer effectively supports the diverging needs of Old Navy versus our traditional specialty brands. Now is the right time for us to take the next step on our journey to both ensure the competitiveness of our brands and to deliver shareholder value.

Next, let me just share a bit more detail regarding the Gap specialty fleet rationalization we announced today. The Gap brand, as Art mentioned, is an important component of both Gap Inc. and the proposed NewCo portfolio, and this is an important step to improve the profitability of the specialty channel.

So we started the year 2018 with 725 global specialty stores, excluding China, which continues to be a growth market for us. Between the 68 specialty stores that we closed this year and the 230 additional specialty closures that we announced today, this represents closure of nearly half the fleet, and there will be additional natural expirations and closures beyond 2020. To identify the stores for closure, we focus on those that were not delivering appropriate levels of contribution, were in the wrong locations or otherwise were not a strategic fit in the fleet. Our objective is to ensure the remaining fleet is located and sized appropriately and can generate sufficient returns toward the investment to remain brand appropriate and provide a positive customer experience. To accomplish these closures, we're balancing the need to move aggressively but economically. There are approximately 150 closures that will take place as leases naturally expire over the next 2 years. In that same time frame, we also are actively pursuing more rapid closures of about 75 and up to maybe 100 stores that do not meet our criteria for retention. We expect the stores with the most significant losses will be closed by the end of fiscal year '19. In total, we expect these decisions to result in annualized pretax savings of about $90 million. It's important to note that we expect an annualized sales loss of about $625 million from the closure of these stores, and we estimate restructuring costs of about $250 million to $300 million, with the majority expected to be cash expenditures. Through this work, we will have a smaller, healthier base of stores that play an important role in the omni-experiences our customers demand. In addition, we'll continue to focus on growth in our online channel, which we expect to evolve to over 40% of our business as we restructure the specialty fleet. We believe Gap brand will be well-positioned to compete effectively with an omni-model that offers locations, formats and experiences that serve our customers' shifting shopping patterns.

Let me now briefly summarize our fourth quarter and full year results. While 2018 presented some challenges, we're pleased to have delivered fiscal year earnings per share within the original guidance we set at the beginning of the year. As a reminder, both fourth quarter and full year results are negatively impacted by the loss of the 53rd week, which amounted to about $0.06 of EPS for the year and $0.16 for the fourth quarter. Additionally, our reported 2018 results include the presentation changes from the adoption of the new rev rec standards, the impact of which is presented on our website.

So to the details. The net sales for the quarter were $4.6 billion with comp sales down 1%. For the full year, net sales were $16.6 billion, up slightly over last year when excluding the presentation changes from the adoption of the new rev rec standards. Comp sales for the year were flat compared with a positive 3% last year.

At Old Navy, Q4 comp sales were flat against last year's 9%. For the year, Old Navy's comp sales were up 3% as we continued to grow share. As Art mentioned, while the Old Navy brand remains fundamentally strong, the fourth quarter was disappointing, particularly in stores. Our online trends remain very strong with double-digit increases in traffic and conversion during the quarter. That said, in both channels, there certainly were macro factors at work, but we also missed opportunities around both newness in product and effectiveness of commercial plans. We've hindsighted some of the execution misses that are within our control to incorporate learnings into next year's plan. The leadership team is also diving in to better understand and quickly correct some product softness we continued to see around women's wovens and dresses.

At Gap, the Q4 comp sales were down 5% against a flat comp last year. As expected, a more balanced assortment helps drive an improvement in margin trends versus last quarter.

At Banana Republic, Q4 comp sales were down 1% against a positive 1% comp last year. The Q4 comp results reflect the team's continued focus on reducing promotional levels, which delivered margin expansion in the quarter but negatively impacted traffic during the competitive holiday season. We continue to be pleased with the brand's progress and look forward to the team continuing to refine and build upon strategies that have driven performance -- improvement in recent performance.

Athleta delivered another good quarter on top of last year's remarkable trends, resulting in a 2-year comp of nearly 30% positive. While Athleta's performance remained strong, we also have a little room to do better there.

Lastly, our online channel had another strong year, exceeding our goal with over $3.6 billion in sales, representing a mid-teens growth rate over last year.

Moving to gross margin. On a reported basis, Q4 gross margin was 35.6%. $123 million or about 140 basis points of expansion was driven by the presentation changes from rev rec adoption. Excluding that impact, the fourth quarter gross margin declined 260 basis points driven by the merchandise margin decline of 150 basis points and 110 basis points of rent and occupancy deleverage, resulting from the loss of the 53rd week. Merch margin deleverage was primarily driven by Old Navy and Gap. With the strength of our online business during the quarter, we did experience some deleverage related to shipping expense. As I mentioned last quarter, we continue to have opportunities to optimize our shipping costs going forward. Deleverage in rent and occupancy was primarily driven by the loss of the 53rd week. For the full year on a reported basis, gross margin was 38.1%. $443 million or about 130 basis points of expansion was driven by the presentation changes from rev rec. Excluding that impact, fiscal 2018 gross margin declined 150 basis points driven by a merch margin decline of 140 basis points and 10 basis points of rent and occupancy deleverage.

On SG&A. On a reported basis, fourth quarter total operating expenses were $1.3 billion. The presentation changes from rev rec resulted in a $123 million increase in operating expenses and accounted for 170 basis points of operating expense deleverage. Excluding that impact, fourth quarter SG&A as a percentage of sales leveraged 270 basis points. This leverage in the quarter was largely driven by a decrease in bonus payments. In the face of a challenging holiday performance and in line with our priority of driving a performance culture, we made the difficult but appropriate and necessary decision to decrease our bonus payout for the year. For the full year, total operating expenses were $5 billion. The presentation changes from rev rec resulted in a $443 million increase in operating expenses and accounted for 160 basis points of operating expense deleverage. Excluding that impact, full year SG&A as a percentage of sales leveraged 100 basis points, exceeding our previous guidance and underscoring both our commitment to delivering results in a disciplined manner and executing against our productivity initiatives. I'm very pleased to report that we exceeded our internal productivity goal by identifying and actioning against about $300 million of productivity savings this year. As a reminder, prior to 2018, we had been deleveraging SG&A by about 170 basis points as we ramped up investments. With the help of our productivity efforts, we were able to increase our investment in technology and digital capabilities while also leveraging SG&A. During the fourth quarter, we finalized our provisional amounts related to the enactment of the TCJA, resulting in a fourth quarter effective rate of 24.4% and a fiscal 2018 effective tax rate of 24.1%.

And turning to earnings. Our fourth quarter 2018 earnings per share were $0.72 compared with reported earnings per share of $0.52 last year and adjusted earnings per share of $0.61, excluding the net impact of tax reform in 2017. Full year 2018 earnings per share, including the benefits of a lower tax rate, were $2.59 compared with reported earnings per share of $2.14 last year and adjusted earnings per share of $2.13 excluding the net impact related to tax reform in 2017 and the second quarter gain from insurance proceeds related to fixed assets.

Our fiscal 2018 free cash flow was $676 million compared with $715 million last year, which included $66 million of insurance proceeds related to property and equipment. We ended the quarter with $1.4 billion of cash, cash equivalents and restricted cash as well as $288 million of short-term investments.

Regarding capital and store counts. Fiscal 2018 capital expenditures were $705 million, below our previous guidance of $750 million as we reduced capital expenditures in response to more challenging operating performance.

And now moving to 2019. On a reported basis, we expect earnings per share to be in the range of $2.11 to $2.26. Excluding costs associated with our restructuring plans, we expect earnings per share to be in the range of $2.40 to $2.55. The guidance range does not incorporate any costs associated with preparing for and executing the separation we announced today. We'll provide visibility to those as the plans develop and as the costs are incurred. As I mentioned, we made the difficult but necessary decision to reduce bonus payout. As we look to 2019, we expect reinvestments in our bonus plan that will better reflect a performance culture, aligning employee and shareholder interests while enabling us to attract and incent talent that is motivated to fuel our path forward. As we reset our bonus payout and lap the minimal payout this year, this may cause our expense to deleverage next year.

With that in mind, let me take you through some expectations for the first half. We do expect the first half to be more challenging. As has been widely published, February has been unseasonably cool. The historically cold start to the year has impacted all of our businesses, particularly Old Navy, which tends to be the most weather sensitive. While we're seeing double-digit comps in seasonal cold weather products such as denim, fleece, sweaters, we're also seeing softness across spring seasonal categories.

Secondly, as I previously mentioned, the Old Navy leadership team is diagnosing some of the product acceptance softness around women's wovens and dresses, which we expect to improve in the back half. Our margin for the first half will be more challenged. In addition to the reasons just mentioned, the Gap brand continues to work through its brand revitalization and fleet restructuring. As a result, we expect an improvement in second half comp and margin trends for Gap brand compared to the first half of the year. Based on this, we currently expect adjusted first half earnings per share to decrease relative to EPS for the same period last year. We currently expect a high teens percentage decrease.

Regarding capital expenditures, we expect fiscal 2019 capital expenditures of about $750 million, which includes about $100 million of expansion costs related to one of our headquarters buildings and the build-out of our Ohio distribution center. Additionally, at the start of the year, we entered into a transaction to purchase our Old Navy headquarters building in anticipation of deferring the gain on sale of another building. The net cash outflow of the exchange is expected to be approximately $100 million to $150 million.

Regarding company-operated stores, including closures related to the Gap brand fleet restructuring, we expect to close about 50 company-operated stores net of openings and repositionings. Openings will continue to be focused on Old Navy and Athleta.

Our cash priorities have not changed. We are maintaining our current dividend rate, which currently provides a 4% yield. However, given the restructuring efforts this year and the spend related to the purchase of the Old Navy headquarters and expansion of our Ohio D.C., we intend to reduce our share repurchase levels in 2019. Our current thinking is to repurchase at least sufficient shares to cover the dilution from our option exercises or approximately $50 million per quarter.

A few other relevant metrics. We currently expect fiscal 2019 comp sales to be flat to up slightly. We currently do not expect a meaningful impact from foreign exchange to EPS in 2019, and we expect a full year effective tax rate of about 26%. Also in fiscal 2019, we will be adapting the new FASB lease accounting standard. The adoption is not expected to have a significant impact on our income statement, but it will result in a substantial gross up on our balance sheet to recognize a lease liability and right-of-use asset for our leases. We're applying the standard prospectively in Q1 with a cumulative adjustment to retained earnings.

So just to close out, this is an exciting time as we position our brands to, once again, play a leadership role in reinventing the retail experience. For the upcoming year, we have 2 priorities: to continue to strengthen the performance of our brands with improved execution and to prepare for the separation that will create 2 new stand-alone public companies that are uniquely positioned to win with customers and for shareholders.

So with that, we'll open it up to questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Our first question will come from Randy Konik with Jefferies.

--------------------------------------------------------------------------------

Randal J. Konik, Jefferies LLC, Research Division - Equity Analyst [2]

--------------------------------------------------------------------------------

Congratulations on the strategic direction. I think it's a great move by the company. I guess, Art or Teri, I wanted to ask, last time we got a disclosure around margins by division, Old Navy was around the mid-teens mark. Obviously, the weather is going to impact that a little bit because of markdowns, et cetera. But I was just curious. Just because people would be interested on the call here to get some sense of how to value Old Navy properly now that it's being split off. Do you see Old Navy as more of that kind of stable mid-teens type of operating margin business? Just curious on your thoughts there of how we should be thinking about that over time, given it's such a very stable-type business model. And then second, as it relates to Gap division, you gave some great color last quarter that showed the various almost profit differences -- margin differences between Gap Specialty versus Gap Outlet versus Gap Online. Any kind of update to that and how we should be thinking about how the store closures of the Gap specialty side help to get to a normalized profit margin rate for the entire Gap division? Because I think that would be helpful for people. As well, how should we be thinking about what could Gap divisional segment margins kind of look like going forward on a normalized basis once these stores are closed?

--------------------------------------------------------------------------------

Teri L. List-Stoll, The Gap, Inc. - Executive VP & CFO [3]

--------------------------------------------------------------------------------

Sure. Thanks, Randy. So you will, over time, get a great deal of transparency on both of the questions you asked. We will, of course, as we move forward towards separation, have audited financial statements for Old Navy that will have a great deal of detail and the same for NewCo. The way we see Old Navy is having tremendous growth prospects, both in terms of the top line growth levers that Art mentioned but also in terms of margin expansion over time. There's no question that, in 2018, Old Navy margins did take a bit of a hit, particularly from the fourth quarter trends that we talked about today. It's just such a big part of the year that it's difficult to recover from that. And as we often do, because Old Navy is such a units business, the most responsible thing for us to do when traffic slows is to move through that inventory, take the necessary markdowns and the margin impact and move forward so that we can continue to start clean. And so we saw those effects, but that is not what we believe is the long-term trajectory of the brand. Very much see Old Navy as having growth opportunity on both the top and the bottom line going forward. With respect to Gap, we talked about the magnitude of the impact of the closures in specialty as we look forward in terms of their contributions to the total company. So obviously, dramatically changing the complexion of the specialty channel and changing the mix of the business across the channels for the Gap brand. We're not going to get into specific margin rates for the Gap brand or the specific channels other than to say that, as we continue to drive forward with not just the fleet restructuring but with the overall brand revitalization, we see, again, opportunity for tremendous margin progress there over time. And we'll certainly continue to paint that picture with the additional specifics necessary to understand the progress and time line as we move through and prepare for the separation.

--------------------------------------------------------------------------------

Operator [4]

--------------------------------------------------------------------------------

Our next question will come from Dana Telsey with Telsey Advisory Group.

--------------------------------------------------------------------------------

Dana Lauren Telsey, Telsey Advisory Group LLC - CEO & Chief Research Officer [5]

--------------------------------------------------------------------------------

Congratulations on moving forward to extract greater value. Art and Teri, as you think about the puts and takes of separating the businesses, we've talked in the past about supply chain, manufacturing systems. How do you think about separate businesses? And they're still big, but what expense changes do you envision from having separate businesses?

--------------------------------------------------------------------------------

Arthur Peck, The Gap, Inc. - President, CEO & Director [6]

--------------------------------------------------------------------------------

Thanks, Dana. It's Art, and I'll let, obviously, Teri chime in on this one as well. And you put your finger on a big part of the work that we've been doing because the benefit of scale and size is a real benefit. To your point, these are still going to be, frankly, substantially larger than the average apparel company -- companies. And so we feel a number of places were far enough down the scale curve that we can actually hold onto that and continue to move forward. We have done some work on looking at what the potential dis-synergies would be. We're continuing to work on our technology stack and some opportunities that we have there. We're certainly doing the work at the back end from a supply chain standpoint. There is a -- I guess, I would point out here, and we'll talk more about this I'm sure. But the -- probably what really got me there, frankly, and why I want to move with urgency on this and I'm so committed to the belief that it's the path forward is that there has been an accelerating divergence between the businesses with the path for Old Navy and the path for the other businesses. And that's also true on the back end with our vendors, where there is more alignment with Old Navy and less overlap with the other brands. The other brands overlap each other but overlap Old Navy less. The other side of it is, is I continue to believe, and I know Teri feels the same way, that we are a long way from done with the productivity opportunity in the company. And we've made progress. In my mind, not enough progress and not progressed fast enough. And I am very acutely aware and focused on the fact that a catalytic event like this can help us potentially accelerate that. So while I'm not going to give you specifics right now, I know you'd really like those, we'll continue to work those. And I'll just reiterate Teri's commitment in her remarks, which is there are a lot of questions we can't answer right now. We are quite confident that we have done the work to get us to this point informing the fact that we believe this is a very significant and important step, and it does unlock significant value creation potential. As we continue to do the work and learn things, we're going to be as transparent as we possibly can to really show you what these 2 new companies look like and what the puts and takes are associated with this, but we're confident it's the right thing to do, absolutely confident.

--------------------------------------------------------------------------------

Operator [7]

--------------------------------------------------------------------------------

Our next question will come from Mark Altschwager with Baird.

--------------------------------------------------------------------------------

Mark R. Altschwager, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [8]

--------------------------------------------------------------------------------

Art, I don't know if you'll be able to answer this at this point, but what strategies do you have in mind for Gap brand that you think will be better executed as a stand-alone company versus part of Old Navy? I mean, do you see major changes on tap to the makeup of the assortment, the target customer, the pricing architecture? I guess, big picture, where do you see Gap's sweet spot in the next chapter of specialty retail?

--------------------------------------------------------------------------------

Arthur Peck, The Gap, Inc. - President, CEO & Director [9]

--------------------------------------------------------------------------------

Well, I mean, the first thing we've done, obviously, is with the step on store closures is to pretty radically remix the channel exposure, and that's important. This is a -- the remixing of the channel exposure is something that every retailer that has been dominant in the higher end of the specialty apparel segment is going to need to do, and I frankly see Gap leading the way in informing some of the things we need to do. We are going to close some stores inside of Banana Republic. Overall, Banana has a much healthier fleet, but we are going to take this opportunity to close some stores that we don't think in the same way have attractive economics or are right for the brand. And we've been pretty purposeful and intentional about, frankly, not building Athleta as a business of the past but rather a business of the future. So it's less about the specifics of Gap brand than the divergence between the needs and opportunities in Old Navy and the needs of the specialty brands. And that divergence is fleet. The specialty brands have more alike in their fleets than not. They both have outlet businesses. Athleta does not. They have an international footprint, Old Navy, less so. And then technology options as well. A simple example would be is that Old Navy's use and need for a mobile POS solution is quite different because of the in-store service model than an Athleta or Banana Republic. And what -- part of what got me here, frankly, and why I really have a lot of energy about this is I found myself in the process of allocating capital and OpEx for investment decisions, increasingly negotiating compromises in the portfolio that, frankly, were the least bad solution versus highly optimized for the 2 different business models. And so I'm a big believer that least bad solutions aren't the best way to win, and therefore a lot of this is just getting that focus, that focus around investments, that focus around alignment of incentives, the purity of what these 2 businesses need to do, and it's going to make the work a lot easier and a lot faster as well. And then there's just a couple of points of alignment, which is I am big on the sustainability thing. It's not that Old Navy isn't there as well. But I think we can get there really fast with NewCo, and we know that matters to our customers. And I think we're going to see it matter to our customers at an accelerating rate. That's kind of a gift with purchase, if you will, but it is an important one for me. I don't know, Teri, if you want to say anything more. No?

--------------------------------------------------------------------------------

Teri L. List-Stoll, The Gap, Inc. - Executive VP & CFO [10]

--------------------------------------------------------------------------------

Well said. I think I've tackled the focus point more and more often over the past year or so. In particular, we have found ourselves having to debate internally what's right for Old Navy versus what's right for one of the other brands. And often, particularly if you think about the needs of Old Navy versus an Athleta, whether that's web investments or data analytics investments or technology tools that, as Art mentioned, more and more often you were coming to quite different answers for Old Navy versus the other specialty brands. And then, as Art said, you're forced with suboptimal choices. So this feels like an absolutely right way to set Old Navy up to continue to exploit its growth opportunities, unencumbered by suboptimal compromises with the other brands and vice versa for the NewCo brand to really be able to continue to focus on reinventing retail and being leaders in their spaces.

--------------------------------------------------------------------------------

Operator [11]

--------------------------------------------------------------------------------

Next, we'll take a question from Adrienne Yih with Wolfe Research.

--------------------------------------------------------------------------------

Adrienne Eugenia Yih-Tennant, Wolfe Research, LLC - MD and Senior Analyst Retailing, Department Stores & Specialty Softlines [12]

--------------------------------------------------------------------------------

Teri, this is a question on the store closures. So the 230, how are they distributed globally? And how many are flagships, if any? And then from the perspective of, I think, you said 150 of them are going to come off of natural lease expirations or lease actions. So the $250 million to $300 million of cash, is that just for the remaining $80 million (sic) [80]? If you can give us any color on that, that would be very helpful.

--------------------------------------------------------------------------------

Teri L. List-Stoll, The Gap, Inc. - Executive VP & CFO [13]

--------------------------------------------------------------------------------

Sure, sure. So the 230 stores are global, but they are largely located in the U.S. So that is where the majority of them are. And yes, there are flags included in that number. We are -- we've really -- Art mentioned this in the earlier calls, we've really challenged the old-fashioned notion of what a flag should be, how big it should be and how much you're willing to invest in negative contribution for a flag. And we have been very selective in retaining a certain number of flags that are, we believe, necessary to drive customer engagement and customer acquisition in key geographies but very thoughtful about how we want those to appear and how many of those we need. So you're right that the 150 that I cited will be the natural expirations which leaves us, call it, 80 million-ish -- or 80 -- 80 stores, not 80 million stores. And those 80 stores are largely what's making up the restructuring costs. There are things beyond closures included in there, you have some severance and...

--------------------------------------------------------------------------------

Arthur Peck, The Gap, Inc. - President, CEO & Director [14]

--------------------------------------------------------------------------------

Inventory issues.

--------------------------------------------------------------------------------

Teri L. List-Stoll, The Gap, Inc. - Executive VP & CFO [15]

--------------------------------------------------------------------------------

Inventory and book value write-off, but that is largely related to those 80-or-so stores. And part of the reason for the number is they tend to be longer lease terms, and they tend to be the flags so there is an additional expense. But we very much have looked at the projected future losses associated with those leases and come up with what we think is an economic way to deal with it.

--------------------------------------------------------------------------------

Adrienne Eugenia Yih-Tennant, Wolfe Research, LLC - MD and Senior Analyst Retailing, Department Stores & Specialty Softlines [16]

--------------------------------------------------------------------------------

And then just in terms of inventory buys for this year for Gap, do they contemplate, say, half of them? Are they at the end of this fiscal year? Are they weighted toward the end Q1 of each of those years? Any...

--------------------------------------------------------------------------------

Teri L. List-Stoll, The Gap, Inc. - Executive VP & CFO [17]

--------------------------------------------------------------------------------

Yes. the closures are -- I'm sorry.

--------------------------------------------------------------------------------

Adrienne Eugenia Yih-Tennant, Wolfe Research, LLC - MD and Senior Analyst Retailing, Department Stores & Specialty Softlines [18]

--------------------------------------------------------------------------------

No, go ahead.

--------------------------------------------------------------------------------

Teri L. List-Stoll, The Gap, Inc. - Executive VP & CFO [19]

--------------------------------------------------------------------------------

Yes. So they are weighted toward the end of 2019, and we are planning our inventory appropriately to minimize the write-offs that would come with closure. And obviously, we're pretty aggressive. We've -- unfortunately, we've been doing this for a while. We know to close Gap specialty stores and minimize the inventory impact. This is a bit larger scale, but we're planning for it.

--------------------------------------------------------------------------------

Arthur Peck, The Gap, Inc. - President, CEO & Director [20]

--------------------------------------------------------------------------------

We're not going to -- I'm not concerned about an inventory overhang that's unplanned here.

--------------------------------------------------------------------------------

Adrienne Eugenia Yih-Tennant, Wolfe Research, LLC - MD and Senior Analyst Retailing, Department Stores & Specialty Softlines [21]

--------------------------------------------------------------------------------

Perfect. Great. Great luck with the new strategy.

--------------------------------------------------------------------------------

Teri L. List-Stoll, The Gap, Inc. - Executive VP & CFO [22]

--------------------------------------------------------------------------------

Thank you.

--------------------------------------------------------------------------------

Operator [23]

--------------------------------------------------------------------------------

(Operator Instructions) Next, our question will come from Matthew Boss with JPMorgan.

--------------------------------------------------------------------------------

Matthew Robert Boss, JP Morgan Chase & Co, Research Division - MD and Senior Analyst [24]

--------------------------------------------------------------------------------

So at the Gap brand, may be Art, what categories do you see a fixable by Spring versus areas you see taking more time? And then similarly, should we expect negative same-store sales at the Old Navy concept in the front half of the year? Maybe just the time frame you see necessary to restabilize that concept.

--------------------------------------------------------------------------------

Arthur Peck, The Gap, Inc. - President, CEO & Director [25]

--------------------------------------------------------------------------------

Well I -- Teri and I were both kind of looking at each other wondering where that came from.

--------------------------------------------------------------------------------

Teri L. List-Stoll, The Gap, Inc. - Executive VP & CFO [26]

--------------------------------------------------------------------------------

Yes, wouldn't have chosen those words, Matt. Maybe we could say -- I think our -- we're not going to give you Old Navy comp guidance for the quarters. But certainly, we didn't mean to imply that there is some tremendous overhang in Old Navy. Quite the opposite. There are a lot of categories in Old Navy that are doing very well. We have the weather, which is a factor for sure. You've seen that in a lot of companies. It's something we're dealing with and we'll work through. And then some what I would characterize as relatively minor product opportunities that we're going to work through in the first half.

--------------------------------------------------------------------------------

Arthur Peck, The Gap, Inc. - President, CEO & Director [27]

--------------------------------------------------------------------------------

Yes. I don't -- in no way, shape or form, I'll just say it again, do I view Old Navy as sick in any way, shape or form. Brand health is good. We're retooling our marketing on the right schedule, which is what we do every period to refresh that.

--------------------------------------------------------------------------------

Teri L. List-Stoll, The Gap, Inc. - Executive VP & CFO [28]

--------------------------------------------------------------------------------

Still growing share.

--------------------------------------------------------------------------------

Arthur Peck, The Gap, Inc. - President, CEO & Director [29]

--------------------------------------------------------------------------------

Yes, still growing share, impressive 2-year stack. I would love to have done better in the holiday. I think we have a pretty good handle on what we should have done to do better. But I don't even -- I was going to say it's not sick. I'm not even sure it's a little cold, quite honestly. I've said for a long time that we're in a business where not every quarter is going to be perfect, and this quarter wasn't perfect. But that is way, way different than there being any fundamental issue with the business model, the health of the brand, the product offering, the capabilities of the team, all of that stuff. So I'm quite confident. And quite honestly, I wouldn't have gone down this path if I felt like we had a repair job on our hands right now. I don't feel that way in any way, shape or form.

--------------------------------------------------------------------------------

Matthew Robert Boss, JP Morgan Chase & Co, Research Division - MD and Senior Analyst [30]

--------------------------------------------------------------------------------

That's great. And then just with the Gap brand?

--------------------------------------------------------------------------------

Arthur Peck, The Gap, Inc. - President, CEO & Director [31]

--------------------------------------------------------------------------------

Well, you said fixed. As we know, fixed is a relative thing. We're -- I'm quite confident in what we're seeing. We're seeing key category improvement period-over-period. You know we brought Pam Wallack in now a few months ago. Pam and I worked together in the last significant successful turnaround of Gap brand. Denim is at the core of the brand and there's a lot of attention focused there. We've made significant progress on the knits business, both on reducing the number of CCs and styles and putting more depth behind the knits as well as improving the quality. And so I -- to me, there's core categories that Gap has to stand for. It has to stand for denim. And as we're getting into spring then into summer, into fall, we're absolutely on top of the high-rise trend, the super high-rise trend, the change in leg-shape silhouette with a straight, with a cigarette, et cetera. And then bringing in a place where we haven't, which is a little bit more wash range and some more novelty, which has been working. We've just been modestly invested in those areas. I am exceedingly pleased with what I've seen in men's, men's development, season over season. And then kids and baby continues to be a very solid, strong business for us. So it's really about women's and those key categories. And denim and knits have been 2 with fleece on top of that, and we're in a fleece moment. We're investing bigger in fleece as we get into spring, summer and fall. It should be a place where Gap should be able to dominate and really own that, and we're putting the investment behind it to make it happen. So again, I've called a turn before, and I've eaten my words. I'm not calling a turn again. What I am looking for is period-over-period improvement, and I'm quite confident and comfortable with what I'm seeing.

--------------------------------------------------------------------------------

Operator [32]

--------------------------------------------------------------------------------

Next, we'll take a question from Paul Lejuez with Citi Research.

--------------------------------------------------------------------------------

Paul Lawrence Lejuez, Citigroup Inc, Research Division - MD and Senior Analyst [33]

--------------------------------------------------------------------------------

Art, can you give us a ballpark dis-synergy range that factored into the equation that helped you determine the separation made sense? And also curious about the website. All brands operate on the same platform. Is the plan for Old Navy to no longer be linked to the other brands online? I'm curious what kind of crossover shopping you have between Old Navy and the other brands online.

--------------------------------------------------------------------------------

Arthur Peck, The Gap, Inc. - President, CEO & Director [34]

--------------------------------------------------------------------------------

Yes. So I'm not going to give you the dis-synergy numbers right now, frankly, because the really relevant number here is going to be what's the net. And as you can imagine in something as material as this, we've been working this with a very able group inside the company, but it's been a small group. We believe we've had the right people inside the tent, as I said before, to make sure that we were stage-gating this and not going to get hung up on a structure issue or a cost issue or a tax issue or something like that. So we are confident that, number one, it's the right thing to do; and number two, we can get it done. We have a lot of work to do on both really getting into the substance of the dis-synergies and then the offset of the dis-synergies. And so Teri and I go back and forth on this, but we both have, I would say, very aggressive objectives when it comes to minimizing the dis-synergies and getting the maximum out of accelerated SG&A productivity, so from that standpoint. On the website, to be determined, quite honestly, how we shake that all around. We do have some overlap with Gap overlaps Old Navy the most; Banana and Athleta, by far, the least; Hill City and Intermix, certainly the least. But I'm not ruling anything out here. And obviously, the world is filled with a number of people attempting to stand up third-party marketplaces right now, third-party digital marketplaces. I have one right here in this company, and so I'm sure Sonia is going to want to, as are the executives in NewCo, going to want to preserve as much economic value as possible, and we figured that one out. So that is a to-be-determined also, but I wouldn't jump to conclusions.

--------------------------------------------------------------------------------

Paul Lawrence Lejuez, Citigroup Inc, Research Division - MD and Senior Analyst [35]

--------------------------------------------------------------------------------

And how about on the distribution center side, how many distribution centers are shared between Old Navy and the other brands?

--------------------------------------------------------------------------------

Arthur Peck, The Gap, Inc. - President, CEO & Director [36]

--------------------------------------------------------------------------------

Yes, we're doing the work. We feel that the assets actually, as physical units, map pretty well to the brands. And so -- and scale really is pretty much inside the 4 walls. All those facilities are operating at a highly efficient level of productivity. So we don't see -- we really don't see the distribution centers as being shared organs. We think it's going to be pretty clean when it comes to mapping to the brands.

--------------------------------------------------------------------------------

Operator [37]

--------------------------------------------------------------------------------

Alexandra Walvis from Goldman Sachs has our next question.

--------------------------------------------------------------------------------

Alexandra E. Walvis, Goldman Sachs Group Inc., Research Division - Research Analyst [38]

--------------------------------------------------------------------------------

Two questions from me. The first one was, as you went through this process, what other structural approaches you considered for this group of businesses and, I suppose, why this one came out top? And then, the second question is on Old Navy. You mentioned in the prepared comments that you think that this brand has an underpenetrated store base. Where do you think that, that store base can get to in the long term?

--------------------------------------------------------------------------------

Arthur Peck, The Gap, Inc. - President, CEO & Director [39]

--------------------------------------------------------------------------------

Yes, on the -- I'm sorry. I was just -- Teri and I were talking very quietly. What was -- the first question again was? Sorry.

--------------------------------------------------------------------------------

Alexandra E. Walvis, Goldman Sachs Group Inc., Research Division - Research Analyst [40]

--------------------------------------------------------------------------------

Yes. The first question is, you've laid out this plan for the 2 businesses. I'm just wondering what other options you considered for the business.

--------------------------------------------------------------------------------

Arthur Peck, The Gap, Inc. - President, CEO & Director [41]

--------------------------------------------------------------------------------

Yes. You can have confidence that we definitely boiled the ocean in looking at all the combinations and permutations here. We felt we wanted to be exhaustive, and we felt we owed it to the board and the employees and our shareholders to look at those, and so we really looked across the whole thing. We settled on this largely due to business logic at the end of the day and then, obviously, how to manage the dis-synergies at the same time. And I hope what this indicates, without attempting in any way, shape or form to preview more, is that, as we said before, we are focused on value creation and have no sort of emotional attachment to a particular combination of these businesses. We believe this is the best way at this point in time to position both of these companies to create more value and more value consistently. But we did look at whether or not, as an example, Athleta should be in a different structure or something like that. And we feel quite confident that these specialty businesses can significantly benefit by being bundled together right now with a much leaner operating model where they can move faster and also have focused investment priorities that really meet their needs and the same with Old Navy.

--------------------------------------------------------------------------------

Teri L. List-Stoll, The Gap, Inc. - Executive VP & CFO [42]

--------------------------------------------------------------------------------

Yes, I would just add to that. You can imagine, when you take a significant step like this, the homework that you do. And just to emphasize Art's point of the range of options, we obviously looked at what do we think we can deliver by staying together and continuing to drive the balanced growth strategy with as much focus and the productivity efforts that are a part of that, all the way to the other end of the spectrum of just sell off each of the brands for what you can get for the -- from them. And we wouldn't want anyone to think that we just said, "Oh, well, Old Navy is going to be great on a stand-alone basis," which we definitely believe, and therefore, by default, we have NewCo. Not that at all.

--------------------------------------------------------------------------------

Arthur Peck, The Gap, Inc. - President, CEO & Director [43]

--------------------------------------------------------------------------------

Not that at all.

--------------------------------------------------------------------------------

Teri L. List-Stoll, The Gap, Inc. - Executive VP & CFO [44]

--------------------------------------------------------------------------------

It was an intentional choice of how best to position each of the brands in a way that can create value, and we really do believe the combination and the unique portfolio that's created by bringing these brands together...

--------------------------------------------------------------------------------

Arthur Peck, The Gap, Inc. - President, CEO & Director [45]

--------------------------------------------------------------------------------

And minimize the dis-synergies and maximize the productivity opportunity. And then on Old Navy stores, I'm not going to really put a number out there right now. There's going to be ample opportunity to talk as we pull the -- essentially the roadshow together for both of these businesses and tell the story. What we have been doing over the last couple of years, because I'm a big believer in this, is placing stores in what would have traditionally been nontraditional markets or locations for Old Navy to validate the strategy, and these might be in-fill locations where, like in the San Francisco Bay Area, you look for the trading patterns and you realize that we're missing stores in key places where consumers are living their lives. We know that there's an opportunity in markets that are smaller than the markets that we've traditionally put stores in. And especially, when you look at those markets and you realize that those are often markets that were served by very traditional legacy retailers, often general merchandise retailers. When a Kmart closes stores or a Sears does or a Penney's as was announced today, et cetera, those markets are oftentimes increasingly underserved, and we've found great success with Old Navy in some of those smaller markets. The rents are oftentimes de minimis. The customers are super loyal. Many customers in those markets, because remember, they -- we have a significant percentage of cash consumers at Old Navy, they actually don't have access to the brand through the digital expression of the brand. And so what's really on our minds is, here, we have the #2 apparel brand in the United States and a significant percentage of the population that doesn't have access to the brand. We think that's a real winning combination.

--------------------------------------------------------------------------------

Operator [46]

--------------------------------------------------------------------------------

Our next question will come from Lorraine Hutchinson with Bank of America.

--------------------------------------------------------------------------------

Lorraine Corrine Maikis Hutchinson, BofA Merrill Lynch, Research Division - MD in Equity Research and Consumer Sector Head in Equity Research [47]

--------------------------------------------------------------------------------

I just wanted to follow-up on Old Navy. How -- if you feel like you've fully diagnosed the problem because I think there were a few fashion misses in 3Q as well. So if you think that, that is fixed for spring? And how quickly could you get that margin back on track at Old Navy specifically?

--------------------------------------------------------------------------------

Arthur Peck, The Gap, Inc. - President, CEO & Director [48]

--------------------------------------------------------------------------------

Yes, there are always going to be a few fashion misses. And if you're going to hold, and I don't mean you specifically, but if we're going to be held to the standard of perfection, that's a tough standard. There's a reason they call it fashion, and there's a reason they call it trend, and there are always going to be some of those. We don't -- if I go back and I compare to Q4 of 2015, when Old Navy just definitively snatched defeat from the jaws of victory in Q4, we had fashion misses. We were over-assorted. We had a bow wave of inventory that we were pushing forward from port backups, et cetera. And that was a mess, and it took us 2 quarters to get out from under that mess, really Q4 and then we started to see the business turn as we got into Q2, and that was a mess. I will say this, again, I'm not going to predict the business turn. If I look at the business right now and I walked it with the team just a week ago and we looked at our product, I believe a little bit of warm weather would see a significant uptick in the business, and a lot of the categories that are in there right now would start to fly out the door. So I don't -- this is not a wreck and redo by any stretch of the imagination. I'm -- again, I'm super solidly -- super solid about the business and about the health of the brand and about the product that we have in the box.

--------------------------------------------------------------------------------

Teri L. List-Stoll, The Gap, Inc. - Executive VP & CFO [49]

--------------------------------------------------------------------------------

As we said, there were a number of factors, as we've done the hindsighting, to make sure that we're well-positioned. And certainly as we start the first quarter, weather is probably number one. The marketing refresh that Art mentioned is going to be able to help us drive some traffic. And then these product fixes in these couple of categories are likely to be more a second-half benefit than first half. But again, you, say, get the margin back on track. We actually -- Old Navy has probably an industry-leading margin and certainly a portfolio-leading margin. So we feel very good about the overall health, but we actually think it can do better.

--------------------------------------------------------------------------------

Operator [50]

--------------------------------------------------------------------------------

Our last question will come from Oliver Chen with Cowen and Company.

--------------------------------------------------------------------------------

Oliver Chen, Cowen and Company, LLC, Research Division - MD & Senior Equity Research Analyst [51]

--------------------------------------------------------------------------------

Regarding the separation, what are your thoughts in terms of the data piece and the digital side with both speed to the consumer and the data scientists that you're employing across the organization and also supply chain? Just curious on how that will manifest in the separation. Because there were benefits that you had, and you also kind of had a customer through different parts of his or her life. So would love your thoughts there. And I think you helped articulate this, but why now in terms of the separation?

--------------------------------------------------------------------------------

Arthur Peck, The Gap, Inc. - President, CEO & Director [52]

--------------------------------------------------------------------------------

Yes. The data piece, and again, I've talked about this. I'm sort of interested in this because I'm not sure we were getting a little bit of benefit -- we were getting a lot of benefit as we talked about our strategy, so I hope we don't get a lot of penalty as we talk about the fact that we're separating. That all said, we've looked very carefully at the data asset, and we believe we have a relevant data lake for both organizations that allows us to continue down the path of everything we're doing. Quite honestly, the use of the data -- again, this is an element of the divergence of the 2 businesses. The use of the data we see as having differentially -- differential benefits in the specialty businesses than in the Old Navy business, whether it's personalization, whether it's marketing, whether it's predictive analytics to inform the buying process. So I don't -- in no way, shape or form do I believe that we have anything other than a significant opportunity that was the same as what it was, and we continue to pursue it. We do have customer overlap, and that's something that we're going to manage. The file will be a property, we think, of both companies. That's something we need to sort out. It's been a healthy and growing file. And again, there are different ways of working through this, marketplace solutions and that kind of thing. So it's an issue. We're aware of it. We're focused on it. And again, as we know more, we'll certainly come back and talk about what the implications are. There was a second question then. I was focused on the first. Or was there? What's that?

--------------------------------------------------------------------------------

Oliver Chen, Cowen and Company, LLC, Research Division - MD & Senior Equity Research Analyst [53]

--------------------------------------------------------------------------------

The second question was just...

--------------------------------------------------------------------------------

Arthur Peck, The Gap, Inc. - President, CEO & Director [54]

--------------------------------------------------------------------------------

Why now, yes, why now, why now. I think as we've talked in the -- sorry, go ahead.

--------------------------------------------------------------------------------

Oliver Chen, Cowen and Company, LLC, Research Division - MD & Senior Equity Research Analyst [55]

--------------------------------------------------------------------------------

No. That's all. Just exactly.

--------------------------------------------------------------------------------

Arthur Peck, The Gap, Inc. - President, CEO & Director [56]

--------------------------------------------------------------------------------

Yes. Why now is, I think, very straightforward. And it may not be the answer that you're expecting. Why now is that we've done this work, as I've mentioned several times, on an ongoing basis for as long as I've been in the company, where we've looked at the portfolio and the parts of the company and where there are other ways of operating the company that we believed led to better business outcomes. Why now was, frankly, that we became convinced, with the divergence of the business models and the needs of each business, the investment requirements of the business and our ability to manage the dis-synergies and get productivity, that it was the right thing to do. And I believe very strongly that, when you come to that point beyond a reasonable probability of doubt, then you move and you move quickly with urgency and with responsibility. And that's where we are right now. So why now was, I believe, absolutely that it's the right thing to do. I'm energized and excited about both of these companies. The most painful thing to me was having to choose between the 2 because I love Old Navy and have an incredible affinity for its business model and the purity of what it does and the growth opportunity in front of it. But I'm also super excited about frankly the gift, the opportunity and the imperative to reinvent specialty apparel retailing because we all know it needs to happen. And I believe we are and we can continue to lead the way at an accelerating rate to monetize these brands in a different business model and surprise a lot of people.

--------------------------------------------------------------------------------

Tina Romani, The Gap, Inc. - Senior Director of IR [57]

--------------------------------------------------------------------------------

That concludes our remarks. Have a great day.

--------------------------------------------------------------------------------

Operator [58]

--------------------------------------------------------------------------------

Thank you. And once again, that does conclude our conference for today. Thank you. You may now disconnect.