Good day , ladies and gentlemen. My name is Stephanie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Gap Inc. First Quarter 2014 Conference Call. At this time, all participants are in a listen-only mode. For those analysts who wish to participate in a question-and-answer session after the presentation. (Operator Instructions) As a reminder, please limit your questions to one per participants. (Operator Instructions) I would now like to introduce your host, Katrina O'Connell, Vice President of Investor Relations.

Good afternoon, everyone. Welcome to Gap Inc.'s first quarter 2014 earnings conference call. I'd like to remind you that the information made available on this webcast and conference call contains forward-looking statements. For information on factors that could cause our actual results to differ materially from the forward-looking statements, as well as reconciliations or descriptions of measures we're required to reconcile to GAAP financial measures, please refer to today's press release, as well as our most recent annual report on Form 10-K and our subsequent filings with the SEC, all of which are available on gapinc.com. These forward-looking statements are based on information as of May 22, 2014, and we assume no obligation to publicly update or revise our forward-looking statements. Before we begin, I also want to mention that Sabrina will be using slides to supplement her remarks, which you can view by going to the Investor Relations section at gapinc.com. Joining us on the call today are Chairman and CEO, Glenn Murphy; and Executive Vice President and CFO, Sabrina Simmons. Now I'd like to turn the call over to Glenn.

Thank you, Katrina, and good afternoon, everybody. Before I hand the call over Sabrina who will take you through Gap, Inc.’s first quarter financial performance, I thought I’d give you my thoughts on Q1 and also remind everybody on the call of Gap, Inc.’s four global priorities. Everybody here was actually pretty disappointed in our earnings results for the quarter. We were below last year and that hasn’t happened to us since the first quarter of 2011 and that was driven by the cotton crisis. So in spite of the fact that the operating conditions were challenging, especially in the first half of the quarter, I expect that we would do better. Now upon reflection we have been doing this now for the last number of weeks, looking at the business because our business is all about continuous improvement and what we are going to do to move our business in the right direction. The product was a little too spring forward and that’s something that’s in our control. I think our customer communications could have been better, that’s also something in our control and our margin management I really thought the team could have done a better job working through inventory we had, especially as they backed up after the month of February and we could have done a better job managing our margins in the quarter as well. All three of those points are completely in our control in areas that the business has embraced and are making the necessary changes as we come into Q2. With that said, I think we have pretty good plans across the business in the second quarter. We are in the business to gain share and our goal is gaining share in the second quarter, third quarter and fourth quarter to finish…

Thank you, Glenn. Good afternoon everyone. Despite a challenging start to the quarter, we continue to focus on levers that drive long-term value. We made progress on our strategic initiative including launching Old Navy in China, Gap in Taiwan and opening additional Athleta stores and we did this while maintaining our operating expense discipline. Regarding earnings for the quarter, in the first quarter, operating income was $443 million versus $530 million last year. Net earnings were $260 million and earnings per share were $0.58 versus $0.71 last year. And as a reminder, we were lapping $0.04 of benefit to last year from the favorable resolution of tax issues. Additionally, we estimate that the impact from foreign currencies reduced our reported EPS growth rate in Q1 by about 5 percentage points. Sales for the first quarter were $3.8 billion, up 1%. Comp sales were down 1% for the quarter. The translation of foreign revenues into dollars negatively impacted our reported net sales by about $20 million in the first quarter. On a constant currency basis, net sales were up 2%. Total sales and comps by division are listed in our press release. Moving to gross margin. First quarter gross margin was down 260 basis points to 38.8%. Merchandise margins were down 230 basis points for the quarter, driven by a challenging February and March which put pressure on our ability to move as many units early in the quarter. Importantly, we did end the quarter with inventory in line with our guidance. Rents and occupancy deleveraged 30 basis points. As a reminder, we need positive comps to leverage rents and occupancy. And the threshold for ROD leverage is higher this year, likely a low single digit comp, given our mix shift toward international markets like China that have higher ROD cost.…

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

Thank you. And we go to our first question from Adrienne Tennant with Janney Capital Markets.

All right. Can you hear me?

Yes.

Well, congratulations on the great start to the year in a very difficult environment. My question is on the inventory change as we go into the back half of the year. Obviously it’s quite improved going into the third quarter. I was wondering, are you making any concessions for what you are now hearing about the West Coast port issues? And then similarly, Glenn, can you talk about the global Gap merchandise changes and what gives you the confidence, obviously volume is improving but some of the changes there, what gives you the confidence that everything is sort of encapsulated in Q1? Thank you.

Thanks. I will start with the inventory piece, Adrienne. So we are very much on track to meet our goal of improving our inventory position as each quarter goes by. So in a tough quarter, we are pleased that we met our beginning of the quarter guidance for end of quarter inventory and we just guided that it’s going to improve by a few points to the end of Q2. We will guide later to Q3 and Q4, but we intend to stay on the path of continuing to tighten as the year goes on, so committed to that, that’s inventory. Regarding the port situation, of course our logistics team is monitoring our situation very closely. We hope of course that it is resolved. But in the meantime, we are very much working through contingency plans as you know following the industry for a long time, it’s not a situation we haven’t faced before. So, we now had to work our plans and how to kick in and take contingency. But we are hoping for a good resolution to that in June.

Hi, Adrienne. Thanks for the congratulations. I’m not sure it’s well deserved but I appreciate it.

Okay. I will say it for Old Navy.

All right. I will take Old Navy in the month of April. In terms of Gap Global, we were talking and I’m not sure we’ve talked about this with our investors. But I know amongst ourselves, we went to our new global model and made the changes that we did. The one quarter, we did circle with ourselves was Q1 2014 for Gap brand, took a look at so many changes that were taking place and so many moving parts that were going on just 12 months ago. I’ve got a lot of faith. I’ve got a lot of belief in Rebekka Bay and Rebekka in the first quarter because some of those transitions were going on, but we executed best we could. But in fairness to her, she wasn’t facing off with her senior merchants, she was facing off with more junior people at the time and transition. She was the head of women's. So, I hope the first quarter with a lot of moving parts and the fact Rebekka was not surrounded by the kind of supporting cast that every great creative director needs, we didn’t have our best first quarter. And I think things got a little bit better. I think the product is slow right now but slightly better than what you saw in the first quarter. I think June gets better and especially as I said in my opening remarks, August, as we move to a full global assortment strategy that that Stephen Sunnucks and Michelle Demartini, who is now the senior partner to Rebekka on the merchandising side and Michelle has got 20 years of experience in our business. I think, I’m not saying wait till August. I would say in August, there is a moment where we go to three key assortments around the world, completely simplifies our business as very clear. However, our good better best strategy across those three assortments. But I've got a lot of faith in what Rebekka in our full team and she has everybody she needs are going to get done. They know they didn’t have the best first quarter and they are accountable for it. But I think that we get better from a pure product to the consumer, as we move into later part of summer and certainly into fall, back couple with the marketing I talked about in the opening comments, I’m counting on speed but that combination will be the magic to get that business back on track.

Great. Thank you very much. Back to work.

We move next to Lorraine Hutchinson with Bank of America Merrill Lynch.

Thank you. Good afternoon. Your consumer are a lot of loyalty to your fit around the world and I was just curious to hear about the extent of your testing before rolling out a global fit to some of your brands?

It’s actually more intense and extensive than I would like it. This is probably the nature of our culture. But when it came to -- that’s an experience, Lorraine, when I started, we had a European fit, the Japanese fit and American fit. And as we started making decisions collectively as a team to move to a global structure, we first start with European fit in that and there is little bit of gross margin left into that in order to liquidate the product properly through Europe and then introduced the American fit, let’s call it, which is now the global fit. And in Japan, we took a little more time and what we are finding out very clearly is we’ve had to make some very, very minor tweaks, what is now the global fit as we bought Japan in. But all the testing we did with our current customers, lapse customers, new customers on the two fits, the new global fit and the old Japanese that which we did over a year ago. Overwhelmingly, people went for the global benefit and the difference was now is managing the size curve. Now funny story, we just had Board Meeting this week and I was just talking to members of the Board when I was in Southern China and then went to Japan right afterwards, I found an extra, extra, extra small and I made a phone call to find out that wasn’t a manufacturing production issue but no, that’s the size curve at work. And so in certain markets that size is prevalent. So in Southern China and parts of Japan, we don’t even have that largest, the highest size we go to is large. So the size curve really gets managed beautifully from the global team, the team we have in New York. And I think that so far so good, not heard anything. And we still got to make sure certain styles that are very Japanese styles like men's cross, which we don’t sell anywhere else. But we sold that in Japan, that's the part of the global assortment. And so I think that we want to make sure we preserve products that resonated in local markets but got to a global fit and you know the reason behind it, besides the simplification to our business. It’s the only way to get the seamless inventory.

Great. Thank you.

And we go now to Paul Lejuez with Wells Fargo Securities

Hey. Thanks, guys. Just thinking about fabric platforming in the second half, I think it has several benefits. I’m wondering if you could just talk about the benefit on the AUC side of the equation and when that starts to kick in. And then just second within Athleta, just wondering which categories in that business are performing best which are lagging? Thanks.

I will start with the fabric platforming, Paul. Certainly, we are making traction on that. So, we have build ourselves internally from start taking it very seriously and we are marching to the goal we set ourselves internally with regard to how much fabric is getting platformed for 2014. With that, certainly should come some average unit costing benefits and that starts in the second half indeed. What I would say though is, we called out that for all of 2014. AUC isn’t a big headline either in terms of headwind because of labor or tailwind because of our tools. I mean, I would say we are managing and we are using the fabric platforming as a critical to all to manage other issues like labor pressures, et cetera. And really the AUC is going to come down to a matter of how our merchant teams and our designers chose to mix the assortment. But we feel, again, like everyone being quite responsible and that average unit costing overall, therefore, it does become a headline.

Just add to that. We started about a year ago with fabric consolidation. I think I may have said in one of the calls, when we start doing some comparisons between ourselves and our three other global competitors. About how many fabrics we actually used in a given year was to say the least embarrassing. So we knew that our creative directors are designers who still had all the flexibility they want in the world because as we dealt directly with Knoll’s which was the second change we made. Their ability to treat the same days cloth in so many different ways was moving in a very fast pace will be quite frank above what we thought was actually doable from some of the leading mills in China especially. So consolidation then went to fever mills doing the work as we build these new relationships and then got to what Sabrina just talked about in terms of platform which has an AUR and then AUC benefit over time. On the Athleta, it depends on the times we are taking about in Q1 which they had a good performance in Q1. The best performing business in terms of pure comp not in terms of its contribution to the overall business but just comp was what the trend itself has built that was about six months that our other brands are capitalizing on little later than Athleta and that’s just a new definition of sweatpants, street wear, soft dressing. And I think Nancy and team just did an excellent jumping on that. And so, it’s so perfect for Athleta as a compliment to could be either during or as you are performing an activity or could be what they say in this business to the activity or from the activity. And that business provided an incredible level of growth for Athleta. Now all that really matters (indiscernible) said and done there is this periphery category, that’s not one, that could actually be permanent category for Athleta as it should be a very strong trend going forward for Old Navy and for Gap, but what matters to me is the performance because that’s what all said and done. We have a nice swim business where these are the complementary business, but what matters to me is performance, performance, performance in a fashion twist. And that business was also ahead of its all store comp, the performance category still did better than all store comp. So I would say the category want deliver the growth we needed and this new which again could end up being two years, three years worth of growth coming from the new street wear trend and perhaps and it’s type of customers I think that could do very, very good for that brand.

Thank you, guys. Good luck.

And we move now to Kimberly Greenberger with Morgan Stanley.

Great. Thank you. When you talked about your speed pipeline a little bit at your Analyst Day, and I know you were hoping to see some impact from that pipeline in the first half, that looks like it will come in the second half. Can you just help us understand the percentage of your inventory flows in the second half that will come through that speed pipeline? And then if you could look out over the next two to three years ultimately when it’s up and running and fully adopted throughout the organizations, what percentage of your inventory do you think you could actually flow that pipeline? Thanks.

Well, this is what I think and what I believe, and then I will probably just answer to what I believe is actually going to happen, because I am such a believer of long-term in all of the responsive supply chain initiatives we are doing, I know the brand presidents are as well and their teams. Speed is something at the recent Investor meeting we didn’t spent a lot of time talking about to be quite honest. It’s been used by our two outlet teams very well because they are simple, they are quick, they are nimble teams and speed has been very important to them. My view of it is that now we have proper platforming pretty far down the line and we’ve got test and respond in a little bit in the back half but very, very strong in the first half of 2015. Then, the next priority is to have rapid response which as you know is a longer living style call it 24, 26 weeks where after the first 10 or 12 weeks as we have read, the second or third flow get adjusted based on real selling patterns as opposed to decisions made by the merchant and inventory management team. So you get, the first flow is put out, you get a read and then you adjust the second and third flow. Speed pipeline, the world class number out there, let’s call it less than 12 weeks. Some are between 40% and 50%. We are in the low-to-mid single digits. In my world, Kimberly, I think I don’t see why with everything I know about our business and the direction it’s moving in our aspiration to get to a much higher operating profit going forward, while the other three components of responsive supply chain will certain contribute to that. I think speed is going to have to get somewhere between 15% and 20% of our business to really aggregate value and I think we talked a little bit in the Investor meeting about culture. I think the culture understands it, it’s behind it, knows it’s right, they are just going to sequence it likely as the fourth priority under responsive supply chain initiatives and probably get a little of benefit next year. Mostly if I was to characterize it for you, I think in the second half of 2015 as an initiative under responsive supply chain, I could see where speed becomes a bigger part of our business.

Great. Very helpful. Thanks.

We move now to Janet Kloppenburg with JJK Research.

Hi, everybody. I had a question on your marketing advertising spend. Several of the companies that I am following as they transition to the digital platform and yield more sales from that channel are gaining some efficiencies and marketing, because it is less costly in that channel than some of the social media venues. And I am wondering if that’s an opportunity that marketing can actually increase, but cost savings maybe inherent because of the channel mix is changing, especially because of the great growth in your omni-channel investments? Thank you.

Yes. Janet, we are starting to make those very transitions and each brand assorted at a different stage. I would say Gap is taking a big lead in moving to digital. We haven’t done TVs in a little bit of time there or maybe actually surprisingly which has for years done the lion’s share of our TV marketing and sort of traditional circular marketing as well. We started talking about in the back half of last year have they started to actually bring television down. And speaking of that in the second quarter coming up here will have two weeks less of television because we are reinvesting that money in other vehicles including not only digital but also our in-store and our windows etcetera. So we are starting to makes that shift. I continue to encourage the teams to look forward strictly at the spend because I think we are getting with the same spend so we just finished the quarter where marketing spend was equal to last year. I would say for the same spend we are getting to your point a lot of good exposure and marketing both all through our digital platforms as well as our traditional platforms. I think we can actually drive efficiency to your point over time and spend less as we shift to some of these other mediums. So I think that is a discussion that is being hotly debated every single quarter as we move forward here. And the teams are definitely looking at all of that.

Okay. And I don’t if we deal this or not, but for the August campaign for Gap, would that be a TV campaign or some combination of TV and other than news as well?

For this coming August more to come on that. Yes, we are in transition with the new agency so that is still in development, but we are definitely going to have a lot of digital materials that can be used for our websites for a lot of different medium. So in progress and more to come.

Great. I look forward to it. Thank you.

(Operator Instructions) Our next question comes from Oliver Chen with Citigroup.

Hi, Glenn, regarding your early comments on the opportunities you spoke about customer communication. I was just curious if you could elaborate there on where you see opportunity and what levers that would drive in terms of the business? Thank you.

My take Oliver was that given the operating conditions that we dealt within the first half of the quarter that we took a step back in our customer communication. That’s less to do with Janet’s question on mediums and content and how to actually get that out to social tools or other tools. I just found that we became reactive, little defensive and used traditional means to communicate value and to drive traffic which is percentage offs way too frequently and we’re too good a company for that. We have very strong brands. Certain brands out there that we have to compete against or near us, but we don’t have a direct competitive opportunity with. I guess that if you’re on the strong brand, then you have to make up for it with more traditional ways of driving customer attention and driving traffic conversion. But when -- in your portfolio you have Gap, Banana Republic, and Old Navy, I just have higher expectations I said in the opening. And if we look at the businesses that did do that, that found the right balance between our enlightened and provocative customer communications because the customers are looking for that these days, found the right medium, and struck the right balance between that and the value proposition, it wasn’t predictable. We had a very good business. Case in point I mentioned Athleta, we don’t give up their comp, they had a very good Q1. And Old Navy, Old Navy is out of the park in April because they struck the absolute great balance between provocative customer communication and a unique way of presenting value. And the other brands know that and they’re going to do that going-forward. I mean this is what we expect of portfolio where we have six brands and three iconic ones, not to be treated like just any brand. So higher expectations going forward, I think the teams know that, even they do, do it. The things little bit more work and it involves more creativity and innovation of thought. We’ll may do, do it, our business and our customers respond . So I’ll be watching very closely and making sure that they get back on track that we expect in the next three quarters.

Thank you. Best regards.

We go now to Jennifer Davis with Buckingham Research Group.

Hey, guys, good afternoon. I was wondering if you could talk a little bit about China. I mean, I know you have invested in it and I think the largest part of your investments are over. But I was wondering if as a region it’s profitable or if there is a certain number of stores that you need to get to, to get to that level. So if you could just talk a little bit about that. Thanks.

We have said for the last three years that it would obviously be a drain on our earnings, as we made investments in people, in our office now of 175 people in Shanghai made significant investments in marketing. It was mentioned in Oliver’s question earlier about brand building that’s especially important. You get lost in the sea of commodities and in apparel in China, if you’re not careful. But I think that the business is really strong. We feel really good about the comp performance of our existing stores that's now a pool. Soon, it would be a pool of 82 stores, sometime in 2014. We have 30 more stores going in this year. We’ll have five to six, Old Navy’s by the end of the year. All of them have online capabilities and went into Taiwan. By the amount of capital, we are spending there, the amount of energy you’re getting to most senior level of the company, China reports directly to me. I think it’s a real strong indicator to our shareholders and the analysts that we believe we’ve got a tiger by the tail. And we think that’s going to be by far our second biggest market sooner rather than later. And feel good about the performance all around and profitability is going to be there because we think we’ve got the economic model, as we project forward and look at the productivity in each one of our stores. We look at the gross margin rate. We think, we can achieve based on three years of operating. Probably, SG&A is going to flow, what the rod is going to look like. We believe the economic model for China is going to be very attractive to the business. But we’re not going to sacrifice, which we may have made that mistake going into new countries in the past, especially with our franchise markets. We’re not going to sacrifice the near to mid-term investments for a real great long-term business. But we feel very good about it. We’ve got a great team there running it and we’re going to continue to make investments. But when it turns to profitability and I’ve not yet declared a date, when it does that, it’s going to move very quickly into contributing profitable country as opposed to what it is today.

And just the dynamic to keep in mind, Gap is improving in its profile every year and so it’s not very dilutive, if you just look at Gap brand. But of course, we just launched Old Navy. So you are going to have to consider the fact that each brand launch also consumes sequence point, a meaningful amount of investment to establish the brand in the right locations with the right marketing. But if you think of Gap brand alone, it’s definitely making progress toward its path to profitability.

Okay. Great. And should we think of that as, kind of, eventually a similar operating margins or potentially higher operating margin than North America?

It’s a little bit soon to tell. I mean, I guess our thesis coming in, was that it’s going to be a strong, very strong online market that’s proving out. As you know that’s an operating margin in that channel is over and above our bricks and mortar business. It’s a little -- on that one, I’m pretty confident. Disproportionately, it’s going to be a very strong online business. The omni-channel, I still believe long-term that it's going to have multitudes, hopefully more than a hundred, very good outlet centers and that also is an operating margin over and above our bricks-and-mortar business. That one -- we’ll see how that one plays out. It’s not heading the same trajectory, I might have assumed two years ago. Looks good and we’re going to open 8 or 10 a year for the foreseeable future. But I’m hoping that will pickup as more developers from outside of China, including Chinese developers build these amazing outlet centers. The 10 or 12 run rate now are fantastic and we just think of the right mix of tenants. So we'll see how that plays out but for us it’s a productivity per foot is better than average than most cases you can assume. We can get a better operating margin for total country than we have in North America. So let’s hope that the sales per foot in China continued at the rates they are right now.

All right. Great. Thanks and best of luck.

Thank you. And our last question will come from the line of Matt McClintock with Barclays.

Hi, Good afternoon, everyone. Glenn, I was wondering if you could talk about, I know it’s a little early but if you could just talk about, you have a lot of initiatives going on, whether that be the global Gap assortment Reserve in Store, Order in Store, et cetera. How do you think about the holiday season or this holiday season, how you plan to address that? Given that you have so many different initiatives going on, so many stories to tell and so many different ways to tell those stories? Thank you.

Sounds a good question. What I can tell you, we may have said on the February call that we really thought we could have done better in holiday 2013. A little bit to an earlier question I used the same word. I think we are little too predictable. And our holiday assortment, our holiday messaging and -- but this is a good customer relatively speaking but they’re not. They need a different kind of communication than the customer of 2007. You got to reach out in a much more different way. They need to really be inspired and engaged in order to participating in brand. We came back in January and the teams right away got involved. It’s fresh on their minds into holiday ‘14 planning. So what I can tell you is that -- that we’re making the necessary adjustments. It’s not -- we’re not quite blowing it up but we are severely changing how we’re going to deal with holiday 2014 starting with product. We’re definitely going to change the cadence in which we speak to customers and we basically looking at a November 1 to December 24 timeline. We know it’s a global business. So it’s not like the opportunity for us is only in North America, it’s a global opportunity to do the right thing in the holiday season, marketing, mix of channels, delivery schedules for online. I think we have torn the whole thing upside down in the month of January and we are really working hard. It’s a very important quarter for us. But we want to make sure we end strong because ending strong, in lot of cases means you can start strong. So lot of great work has gone on to get ready for Q4 and I think happy maybe in the call in August to fill you in more.

Thank you very much.

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

Thank you. That concludes our conference. You may now disconnect.