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 2017 Conference Call. At this time, all participants are in a listen-only mode. As a reminder, please limit your questions to one per participant. I would now like to introduce your host, Tina Romani, Director of Investor Relations. Please go ahead.

Good afternoon, everyone. Welcome to Gap, Inc.'s fourth quarter 2017 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 descriptions and reconciliations of non-GAAP financial measures, as noted on page two of the slides supplementing our remarks, please refer to today's earnings press release, as well as our most recent Annual Report on Form 10-K and our subsequent filings with the SEC, all of which are available on gapinc.com. These forward-looking statements are based on information as of March 1, 2018, 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. As I mentioned, we will be using slides to supplement our remarks, which you can view by going to the Investors sections at gapinc.com. As always, the Investor Relations team will be available after the call with further questions. With that, I'd like to turn it over to Art.

Good afternoon, everyone, and thanks for joining us. I really appreciate you spending some time with us this afternoon. I'm going to speak for a few minutes and then turn it over to Teri, who has a slightly longer conversation today just because of the various moving parts associated with this. But the capstone is that we're pleased to share the results of another very strong quarter. While the fourth quarter is an important one for all of the obvious reasons, posting such strong results is especially notable as we lapped a strong holiday last year. In a moment, I will turn it over to Teri, who will share more details, but before I do, as we close out 2017, I'd like to reflect on our progress in the quarter and in the year. Similar to last quarter, I'll be using the framework of our balanced growth strategy to walk you through some key takeaways. First, we are growing value in Active, beginning with Old Navy. During fiscal year 2017, Old Navy grew 6% and surpassed $7.2 billion in sales. Old Navy is the fastest-growing major apparel brand in the U.S. among major retailers. The brand continues to win by focusing on loyalty categories, delivering on assortment with clear filters focused on fit, quality and value, and I have to point out that more than half of Old Navy's assortments sits on our responsive capabilities, allowing us to feed units into the business, minimizing risk and maximizing margin, and successfully chasing market share opportunities. Nearly all categories comped positively this last year, and importantly, both stores and online saw strong top-line and bottom-line growth. We also accelerated Old Navy store openings, as we had indicated in our strategy presentation back in September, with all the – over 30 new stores…

Thanks, Art. As Art said, there are a number of moving parts here. So I'm going to walk through them I hope with enough transparency, and then obviously, Tina and I and others will be available as necessary to help walk through in more detail, if needed, after the call. But as I've mentioned, we're pleased to deliver another quarter of strong results as we continue to make progress against the balanced growth strategy we outlined in September. Our brands are stronger than they've been in many years and our efforts are focused on where we can have the most impact. With our productivity initiative available to fund our investments in the business, we expect the benefits of recent tax reform to provide a meaningful increase in future earnings and cash flow, a step change in our value creation model. Moving through the fourth quarter and full-year performance to start. Just note that all the results reported today are inclusive of the 53rd week, with the exception of the comp sales metrics. So, let's start with sales. The fourth quarter marked our fifth consecutive quarter of positive comp sales and our sixth consecutive quarter of gross margin expansion. This was a very strong holiday period for us, particularly considering, it's against our most difficult comp comparisons for the year. Net sales increased 8% to $4.8 billion for the quarter and 2% to $15.9 billion for the year. Comp sales were up 5% for the quarter and 3% for the year. The addition of the 53rd week was the primary driver of the positive 3% spread in the fourth quarter. Regarding the sales growth for the year, the impact of the 53rd week was largely offset by the impact from our international closures last year. Going to the brand level. As…

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

Our first question will come from Randy Konik with Jefferies.

Yes. Thanks a lot. Art, when you were at the competitive conference of mine, you gave some very helpful color around divisional margins, which I believe were from 2016 calendar. The glaring opportunity it seemed in that chart you put up was in the Gap division, where I believe the segment margin was in the low single-digits, which contracted with Old Navy, where the margin seemed to be in the mid-teens area. So clearly, it feels like you're getting nice operating leverage in the model for Old Navy, good AUR increases and, obviously, some difficulties, you mentioned, in the Gap division. So, I guess, just want to get some color on what you think can be done or you're doing around driving divisional margins higher in Gap, what type of timeframe we should expect around those strategies, and what you think would be a more normalized type of rate that we could maybe expect over the medium term? Because that could be a very good opportunity for the whole organization, corporation to drive further value, cash flow higher in the future? Thanks.

Yes. Randy, I actually was – I sort of stop listening. No, I'm kidding. But when you said, you had competition, I got hung up on that. So let me just – let me give you a few comments on this and I'm not going to give you an update on a rate perspective as we haven't refreshed that information. But again, I want to point out the fact that the issues were operational. We've started to see this really, as in later parts of Q4, Teri and I dug in, saw what we saw. I made a very quick change. It is not a product aesthetic issue. We're not seeing product acceptance issues. We are not having quality issues or fit issues, so that's the good news. I would look at this, and in some respects, it's quite similar to what Old Navy – the bump that Old Navy hit in the road in Q4 of 2015, which was, at that point, from the port crisis where we had quite unpredictable and late arrivals of product coming in, it is not to the scale of what we had going on at Old Navy. But the thing that gives me confidence here or frankly getting our legs back under as quickly, is that it was less than two quarters when we had that business back on the rails and running well. Product reboots, creative reboots, we've seen them across the industry. Those take a long time. This is nothing like that at the end of the day. So – and then underlying that, obviously, is we're continuing to see strong results in the online business, which is margin-accretive as we go down that path. We're continuing to grow the value sector underneath the covers inside of that business and rationalizing specialty. So those are the longer-term aspects of getting margins back up again. You're right that it's a big opportunity and I am relentlessly focused on it. This did not make me happy. I took action and I'm in it with a good leader, and we feel like we can get things moving pretty quickly.

Appreciate that. Thank you.

Next, we'll take a question from Matthew Boss with JPMorgan.

Thanks. Congrats on a nice quarter.

Thanks.

Thank you.

At the Gap concept, can you speak to the performance in your more loyal categories, jeans, lingerie, baby? And then separately at Old Navy, can you speak to the cadence of business as the quarter progressed? And did you see the momentum from the fourth quarter carry into February so far?

Yes. I mean, if you look at Gap, we've seen good performance across a number of the key categories. We're seeing the body business lift. We're seeing outerwear – I'm sorry, the Active business quite strong. KB (43:13), we've cleaned up the aesthetic a little bit but it's always a franchise category in there, and we've seen some very good performance out of women's denim as well, with knit and woven tops and dresses and skirts. We've struggled a little bit in the men's business. Part of that has been service levels. And then we've seen very good business in men's wovens bottoms as well. So it's been of a mixed bag but most of the key franchise categories we feel like we continue to have strength in. And again, we're always going to have opportunities when you walk a store and you say, jeez, did that execute well or was that the best idea, but we do not have any broad scale product acceptance issues really across any of the divisions in the business. On Old Navy, I'm not going to – I don't – we don't guide for it on the quarter and things like that. So I just don't really want to go there. They, obviously, had a super strong Q4 and it was very diversified, which was the point of my message in terms of the performance across the key divisions in the business. It was not relying on any one particular horse to pull the cart. And a diversified portfolio with good product acceptance, good success, good inventory levels, et cetera, we feel that's the strength they carry, obviously, coming into 2018.

Our next question will come from Ike Boruchow with Wells Fargo.

Hi, thanks for taking my question. Teri, you help us out – you gave us a lot of information. I was just hoping sort of – my question just to focus on the merch margin line. Can you just take a part – the 180 basis points of merchandise margin that you saw in Q4, how much of that is core go-forward GPS merch margin? And how much was related to any kind of insurance gains or one-time gains you might have saw? And then just stick with merch margins. The comments that were kind of made about Gap brand and inventory, does that make us think that the merch margin plan for the fiscal year is more of a first half versus back half kind of setup? Or are you going to be able to smooth that out with strength in Old Navy and whatnot? Thank you.

Yes. So on the Fishkill impact on merch margin, 180 basis points, it was a very modest impact because the proceeds are largely offsetting costs and it's really just a timing issue when those costs recognize. So I don't know, maybe 20, 30 basis points, nothing major. In terms of how we look forward on merch margin or gross margin, given the Gap situation, we are not going to get into quarter-by-quarter guidance. But what I would say is that I look at them as somewhat independent, so in Gap brand, we do fully expect or probably have a little more promotional pressure in the first quarter or two. Expectation, as I've said, is we should be able to work through this. The Old Navy momentum, we have every reason to believe we'll continue to see that strength, are positioned well coming into the year. I don't know that I would necessarily say they're going to be able to offset each other. I think of them as different. On the other hand, as Art said, we're going to be working super aggressively to get Gap on track as fast as possible with as little impact.

Great. Thanks.

Lorraine Hutchinson from Bank of America Merrill Lynch will have our next question.

Thank you. I wanted to ask a question about wages. With many competitors both on and off-mall increasing salaries and hourly wages, are you seeing any of that pressure? And also, you mentioned service levels at the Gap. Are there places or pockets of your stores where you do need to continue to invest?

Yes. On wages, we had wage initiatives several years ago where – when Glenn, before me, took some action on wages. And what I would say is that we're always – the average of our wages isn't meaningful. We're always making sure that we're competitive in any given market that we're in and we'd seen significant differences across geographies. What I would say is we are not seeing any particular acute wage pressure anywhere right now other than the normal market forces of, if you're hiring in downtown San Francisco, there's a lot of competition and it's different in other parts of the country. But none of those are anything that are different than what we've continued to see. So I wouldn't signal something that's discontinuous there at all. On service levels, I did mention the fact that we were putting some payroll back into our stores, and I just want to clarify that because there's two components of service levels. One is the payroll in our stores facing our customer and a lot of that has really been highly aligned with making sure that we're matching hours to footsteps to maintain or accelerate conversion. And that is the line of sight to a return that is very easy to see, and we'll do that. And I always – I'm always focused, as I am with a dollar of marketing, which is, if I spend $1 and get $2 or $3 or $5 or $10 back, that's an easy thing to do. The other component of service levels is inventory depth, and that's where we have had some issues, both in Gap Outlet and Gap Specialty. And some of the incremental inventory is against bringing our available inventories up on the floor so that people have a better chance of finding their size, style, color combination and can walk out with a bag in their hand. And much of that is not in fashion. It is much more oriented towards basics and seasonal basics, where there's relatively minimal liability risk.

Thank you.

Chethan Mallela from Barclays has our next question.

Hi. Good afternoon. I wanted to ask about the Buy Online, Pickup in Store test that you've launched in a couple of cities. Can you just talk about how that's gone so far and any initial learnings that you've had? And also how you're thinking about may be the pace and magnitude of rolling that out and any commensurate investment?

It's really been in two cities so far and constrained to Old Navy. We put no marketing against it other than the availability as we see people geographically where they're coming in. So far, without giving you numerical specifics because it's early days and a relatively few number of stores, we've been extremely encouraged by the results that we've seen here. And the encouragement is the uptake, number one; number two, obviously, the number of people who then come into our stores and build a basket around something that they've already bought online or are picking up in the store, that's very encouraging. We are going to operationalize it, both at the store level and the technical operationalizing it, which we're still working on, but it's been pretty seamless so far. As we get to the middle of the year, we're looking at a broader-based rollout in Old Navy and then we consider when we go to the other brands. I don't have a hard schedule yet because we're just not there yet right now. I mean, the biggest issue is you're taking, you're connecting digital to physical. And when you go from 2D to 3D, there are always challenges just to make sure the customer's experience really delivers the way that you wanted to deliver, and that's what we want to make sure we get right before we present it to all of our customers. The other thing which is often not talked about is we're also excited about it because it does give us a safety valve for fulfillment capacity for our direct business without significant incremental expense below the line. And that's a really nice economic benefit and investment benefit. As volume pivots to BOPIS, it does allow us to take some of the pressure off of our direct fulfillment centers. And again, it doesn't drag through fulfillment cost below the line. So it's very attractive from an economic standpoint.

Great. Thanks so much.

Cowen and Company, Oliver Chen has our next question. Oliver Chen - Cowen & Co. LLC: Hi. Thank you. Art, regarding Gap division, what are your thoughts on how you are monitoring the conversion versus traffic and what we should expect to see over time there within that division? And any goalpost in terms of what you're looking for as we monitor on the Gap division over time? And a second related question is on the consumer engagement model. You mentioned engagement a few times in your prepared remarks and a lot's been changing with engagement and the integration of data and the CRM. Could you just elaborate on what you're seeing with engagement and where you see the opportunity is? Because you have a lot of very good technology that you've been ahead of the curve on there? Thank you.

Yes. On Gap, as we noted, our traffic has been strong, and that's probably the most frustrating part for me here is because of some of the operational difficulties, we don't have the product fully presented in front of our customers, frankly, to monetize the traffic we have in our stores. That said, we're not having to interrupt planned marketing efforts coming out with the Sarah Jessica Parker line. We worked very hard to make sure that we had the product there to align with the marketing. Same is true on our colored bottoms message that we're coming out with now as well. So, I don't want to go into specifics here. But if you have misses on product deliveries, obviously, that has the potential to impact your conversion. But at the moment, what we're really trying to do is to make sure that we build a plan around the product that we have and that we don't over-discount product even if it comes in late relative to its out dates because much of the products in the spring and summer time period is not immediately acutely liable. So we think that it's saleable. So again, traffic is strong and we're working to make sure the rest of the levers in the box don't move negatively as well, but we do expect there to be some promotional pressure. On the engagement part of it, this is really important. We talked about this back in September and I have referred to it again. We now have and have pulled together, as we built some pretty significant analytics capabilities here, and data science capabilities, a few of the customer longitudinally that we've never really had before. And that is across brands, across channels, across categories and divisions. And we have a much…

Yes, what we find and this isn't just Art saying it because Art wishes it to be true because that usually doesn't achieve anything. This is Art saying it because our customers tell us this and our non-customers tell us this, which is we have the permission across a very broad demographic to participate in our customers' lives, and they are giving us that and not all of our brands are that way. The fascinating thing about Gap brand is that many millennials haven't experienced Gap brand except when they were kids and their parents were dressing them in Gap brand clothing and yet there was a very positive orientation towards the brand. And I come back to a couple of pretty simple principles, especially when it comes to physical retailing, which is stores are relevant if stores offer something that you cannot find anywhere else that is relevant to you as a consumer, and high touch is one of those things. It's part of the reason we're continuing to put some payroll dollars back where we see a payoff. But then, we, as retailers, broadly create a lot of friction in our store experiences. So our mantra inside the company right now is high touch and low friction, and we think that actually defines a pretty compelling opportunity for converged retail. Oliver Chen - Cowen & Co. LLC: Thank you. Thanks for all the details on LTV.

Our last question today will come from the line of Brian Tunick from the Royal Bank of Canada.

Great, thanks. I guess first, maybe for Teri, lots of real estate projects, some puts and takes including, I guess, we're lapping Times Square. Can you may be talk about how we should be thinking about ROD and leverage opportunities into 2018? And may be Art, can you talk about marketing as a percentage of sales or increase in dollar spending in 2018 versus 2017? And how you're sort of measuring the ROI on this increased marketing spend? Thank you very much.

Yes. So happy to spend some more time off-line in terms of some of the puts and calls we watched through today. But broadly speaking, as we think about ROD in particular, we will continue to have a little bit of, I guess, a little bit of ROD pressure, as you think about the investments we're making, many of them are capital investments that then come into the asset base and so there's some depreciation there. But having said that, nothing has really changed in terms of what it takes for us to leverage ROD. So it really is a function of how we deliver the sales growth.

Then a comment on marketing as well?

Yeah. Again, we've talked quite a bit during the course of this year about stepping up our marketing spend, and as both Art and I alluded to, we feel very good about the returns we are seeing on those investments. You can see them in the brand engagements and sense of the brand health and then, obviously, very visibly in the traffic trends. I mean, we included a slide in our presentation with traffic trends across the brands and it's pretty remarkable to see a chart with so much green and particularly to see a meaningful number of periods and brands with absolute positive traffic in this environment that's quite good, and we attribute that to some of the advertising activities we've been willing to invest in. So, we'll continue to be super disciplined about balancing out that spend and making sure that we continue to see an attractive return before we step up and expanding for sure. For the most part, it's continuing at about the same rate as we have seen.