FOOL CONFERENCE CALL SYNOPSIS*
By Debora Tidwell (MF Debit)

The Gap, Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GPS)") else Response.Write("(NYSE: GPS)") end if %>
One Harrison
San Francisco, CA 94105
(415) 952-4400

UNION CITY, Ca., November 15, 1996/FOOLWIRE/ --- The Gap, Inc. reported third quarter 1996 results on November 14th. Sales for the quarter were $1.38 billion. That's a 20% increase over last year's $1.16 billion in the third quarter. As they reported last week, on a calendar-adjusted basis, that is an 18% increase. The comps for the quarter are up 1%, this is flat to a year ago. This is the first third quarter in which they have had positive comps since 1992. For the quarter, Gap was negative mid-single digits, Gap Kids was positive low-single digits, and Banana Republic was positive mid-single digits. Old Navy, which is in the comp base but they don't break it out at this point, continued its exceptionally strong sales pace, exceeded its plan for the quarter, and given total company sales it is obvious that Old Navy had an impact on the total numbers and had an exceptional quarter.

SALES PRODUCTIVITY. For the third quarter in a row, sales productivity increased. Sales per square foot were up to $114 for the quarter versus $112 a year ago. When they started expanding stores a few years ago, it had a dilutive effect on sales productivity. That seems to have turned around this year and they are very happy about that.

MARGINS. Margins net of occupancy was 39.4% or essentially flat compared to last year's 39.6%. Merchandise margins themselves were lower by about 100 basis points. This was offset by occupancy costs also being lower, particularly at Old Navy, by about 80 basis points. Old Navy has lower occupancy costs than the other mall-based businesses. They think for the next year they will get some leverage from Old Navy. This will gradually decrease as the newer stores will not necessarily be in the cheapest locations. They benefitted greatly this quarter from a combination of very strong sales combined with lower occupancy at Old Navy. As long as Old Navy becomes larger as a percentage of the total company's business, as long as its operating margin or merchandise margin is higher than it had been previously, it has a positive effect on gross margin and operating margin. With regard to merchandise margins, despite somewhat higher initials, performance of Fall merchandise was such that it required them to sell a bit more at markdown in the third quarter than a year ago. The markdown sell through rate was below last year's record levels but still quite a bit above the rates they have averaged over the last several years.

OPERATING EXPENSES. Operating expenses increased 60 basis points from 23.1% a year ago to 23.7% this year. There are two reasons for this. The first is that they spent more on advertising and marketing of their brand. This is part of a strategic move they have been talking about over the past year or so, increasing the investment in advertising and marketing. They expect that to continue over time. The continued strong year to date earnings performance measured against their annual targets also added another 20 basis points in bonus expense in the quarter compared to last year.

INTEREST INCOME, TAX RATE, NET EARNINGS. Interest income was just over $5 million versus $2 million a year ago. For planning purposes it should be close to $5 million in the fourth quarter as well. Pre-tax return on sales was 16.1% this year versus 16.7% a year ago. The tax rate is unchanged at 39.5%. They are working on finding ways to reduce that over time. The third quarter net earnings increased 15% to a record $134 million versus $117 million a year ago. The third quarter earnings is the fourth consecutive third quarter in which they have had double-digit earnings increases. Last year it was 25%, in 1994 it was 19%, in 1993 it was 27%. They feel it shows that they can generate earnings growth even when the comparisons aren't so easy.

RETURN ON EQUITY. Return on equity for the trailing four quarters was 26.8% and their earnings per share actually increased faster than the net earnings, they increased 17% from $0.41 a year ago to $0.48 this year. Of course, this was aided by the conclusion of their previously announced 18 million share buyback program. They said they would do it over two years and they did it literally almost to the day two years later and it contributed to the EPS growth faster than earnings growth. Their after-tax return on sales was 9.7% versus 10.1% a year ago.

TOPLINE GROWTH KEY. In summary on the third quarter, they are pleased to have delivered growth against the difficult comparisons. The earnings growth was in line with their long-term targets. Obviously the EPS growth was even better than that. And they think topline growth was the key. They know people focus on comps on a monthly basis and it's not unimportant, but in The Gap's case topline growth is becoming more important as they add square footage. All the divisions, all the businesses, were involved in the topline growth but they would like to single out Old Navy whose performance in the quarter was outstanding.

YEAR-TO-DATE. Sales improved 26% to $3.616 billion from $2.873 billion a year ago. The year-to-date comp store sales growth was a positive 6% versus negative 2% in the first nine months last year. On a divisional basis, both Gap and Gap Kids for the year to date period had positive mid-single digit comps and Banana Republic had positive high-single digit comps.

MARGINS FOR YEAR-TO-DATE. Margins for the nine months net of occupancy were 290 basis points above the first nine months of 1995. The increase was due to higher merchandise margins primarily a combination of higher initial and more regular price sell-through and also lower occupancy costs. The increase was about equally split between occupancy and margin over the nine month period. Their operating expenses for the nine months were about 150 basis points higher, from 23.6% last year to 25.1% of sales this year, mostly due to the bonus accrual and advertising which was already discussed.

NET EARNINGS YEAR-TO-DATE. Net earnings for the nine month period increased 41% to $282 million, from $199 million a year ago. Earnings per share are $0.99, a 34% improvement over the $0.69 per share a year ago. For the first nine months, all of their divisions were profitable, all of them achieved increased earnings over last year.

CASH POSITION. On the balance sheet, cash and investments including both short and long term investments were at $625 million at the end of the quarter versus $448 million a year ago. Aside from being essentially debt free, they have more cash now than when they announced the stock buyback two years ago and spent $450 million on it.

CAPITAL EXPENDITURES. Capital expenditures year to date are $237 million net of disposals compared to $214 million a year ago. Depreciation for the first nine months was $137 million versus $126 a year ago. Their forecasts for the year remain unchanged of somewhere between $190-200 million for depreciation. They have completed the 18 million share repurchase at approximately $450 million. Capital expenditures for 1997 are going to be between $400-$450 million (not all of that is stores, there will be delivery centers and other things) instead of the $350 million it is at today. They are increasing their investment in store growth. Square footage will increase closer to 18% in 1997. Even domestically, there are continued growth opportunities, especially in their proven concepts. Beyond Gap and Kids, there are certainly many opportunities for Old Navy and particularly for their freestanding Baby Gap stores. They think they do have great name recognition and they are going to try to capitalize on it.

EXPANSION/NEW OPENINGS. They opened 69 new stores in the quarter and closed 3 and they expanded the size of 11 of their existing stores for a net increase in square footage over last year of 16%. In 1997 store growth will be significantly greater than they had in 1996. They are opening a total of about 200 stores in 1996. In 1997 that number will be around 275 stores. That will break down to, including combination stores, as many as 70 Gap; as many as 70 Kids stores including potentially as many as 50 Baby Gap only stores; about 30 Banana Republic stores; about 30 stores internationally focusing on Germany, France, the UK and Japan; and as many as 75 Old Navy stores. It could be more than that, but at least 275.

GOALS FOR FOURTH QUARTER. For the comparable 13-week periods in the fourth quarter, their goal is to get at least 15% sales growth, which implies low-single-digit comps. They might have been a little more optimistic in terms of the comp number as they entered the back half of the year, but realistically given the performance in the third quarter and for planning purposes it is appropriate to set the comp expectations a little lower. Last year's fourth quarter had an extra week which accounted for about $55 million in sales. Therefore when they publish fiscal increase in total sales it would be 13 weeks versus 14 and the growth rate if they achieved, for example, 15% on a calendar basis would be somewhat lower than that. From a margin standpoint, they do have some opportunity for margin increases in the fourth quarter because they entered with slightly higher initials, but they cautioned that as they saw in the third quarter it was a little bit of a reality check in this area. It doesn't always convert to higher maintained margins. It is all, again, going to depend on customer acceptance of the merchandise. Operating expenses, they expect, will be up for the full year but essentially flat to a year ago in the fourth quarter.

NEW APPAREL FEATURING NBA LOGOS. They talked about some of the long-term opportunities facing them for growth of their brands and there are a couple of recent examples. The first had to do with their test of Gap NBA merchandise which is in 34 stores as of yesterday. The New York Post headlined "Gap Slam Dunks." This is a test of merchandise in 3 cities (New York, Los Angeles, and Chicago) and one store in San Francisco. It involves the Knicks, Bulls, and Lakers. In each city, the stores have that city's team's merchandise, with two exceptions -- the store in San Francisco and the store in Manhattan at 34th and Broadway have all 3 teams represented. This is not what you think of as typical licensed sports apparel. These are not jerseys. This is Gap Kids and Baby Gap merchandise done with a twist, done with NBA team logos and not even exclusively in team colors. The business, particularly since there's a lot of boys involved, is addressing the need for growth in the boys' area in their kids' business just like the men's area in Gap. It gives them a lot more opportunity if it is successful and they think it is something really unique that no one else is doing and the NBA is very excited about even the baby side of the merchandise. All of these things as well as things like combination Gap and Gap Kids stores in smaller markets offer them increased optimism about their format going forward.

THE JAPANESE MARKET. Their flagship store in Tokyo opened earlier this month. They are incredibly excited about Japan and think they could have an enormous business there. There are 7 stores there today and they will have a couple more by the end of the year. In their plans for next year they are adding more stores in Japan. That market has been very receptive to The Gap merchandise and they think it just shows them that they are maybe better known around the world than even they thought they were. Japan is expensive, but their approach so far has given them better real estate locations than they might have if they had aligned themselves with a specific partner.

PERSONAL CARE ITEMS IN GAP KIDS AND BABY GAP. They have put personal care items in the Baby and Kids Gap stores. They have various scents for the products including "Puppy Love," "Bunny Hop," "Just Ducky," and "Sea Monster." These are large size, good value personal care items that are done in a way that is really fun. They are only in 20 stores now, but they will be rolling out to more stores over time. There are a number of fun things beyond the personal care items including sponges in the shape of animals for kids and tie-ins with the merchandise in terms of t-shirts.

BANANA REPUBLIC. They introduced some gift items in the Banana Republic stores. Eight stores have a more complete assortment, but most of the stores have a handful of items including velvet pillows, picture frames, and martini glasses. The good news is that they now have a lot more merchandise and a lot more concepts than they have room for as opposed to having bought a big store and don't know what to put in it. They are looking at a handful of locations for Banana Republic next year which will be larger format stores that will better accommodate the broader assortment and allow them to do a few things of an experimental nature to see what fits. That business of all of their brands is more "lifestyle" oriented so they can do a few more things there. Bathing suits are a great example of how you use a small amount of square footage in a store seasonally. Other ideas are pajamas, martini glasses, holiday. Figuring out what the dynamics are are really important in figuring out whether to do a lot of them or just a handful of them. They are still in an experimental phase where they are trying different things to see what the brand can do.

OLD NAVY. Old Navy celebrated its first birthday last weekend. It is not the rent structure about Old Navy that has driven them to look at its future a little differently. Their intention all along was for it to be a really enormous business where they saw an opportunity in which they thought they could do a good job at that is consistent with the level of performance people have come to expect from them over time. The third quarter of this year in total has shown them the acceptance level is far broader at a far earlier stage. The first Old Navy store opened in March of 1994 and that business is already quite large considering there are only 186 locations. So, they are being a little bit more aggressive than they originally planned. The locations in the near term will be, for the most part, consistent with what we have already seen -- strip malls and power centers will still dominate. There are a couple of exceptions. In 1997 they are opening a flagship store on State Street in Chicago. That would be the first time outside of New York that they are going to try a large scale store. They also decided they will do another one in San Francisco, but it won't open in 1997. They have two mall-based Old Navys -- the one in Syracuse and one in Mall of America -- and these are not a typical mall to draw any conclusions from. They have decided internally to try some mall locations to see what it tells them. The nature of malls in America is changing. We don't just have the "A" malls with the typical power players in there. There are malls that are changing in nature -- some are becoming more discount oriented. They have some malls that they maybe would not have gone into or have withdrawn from over the years as they upgraded the Gap portfolio that offer great opportunities for Old Navy. So they are going to test a number of those locations. They believe certainly from a revenue standpoint that Old Navy will be bigger than The Gap domestically and it also, like all the brands, has international potential. They are going to hold off on that over the near term though. Their target was to get to high-single digit operating margins over time. Clearly they are getting there faster than they thought and see upside from that. It is still, however, not the same operating dynamics as the mall-based businesses. It still has higher advertising expenditures as a percent of sales. It still has lower merchandise margins than the other businesses. It still has lower operating profit than the other businesses. They are pleased at how quickly it has grown both in sales size and profitability and are ahead of their internal schedule. What Old Navy has shown them is that despite its success in some of the areas that are more fun like the gadgets, they are still primarily an apparel-driven business. They think you go into Old Navy and see a lot more entertainment and a lot more fun, but it is still a relatively small part of the overall sales pattern. They expected that and are finding that the actual is that also.

DISCUSSION OF PERFORMANCE BY AUDIENCE. In terms of men's versus women, all of the businesses have performed really well. Looking at all of their divisions and brands, Gap's men's business has been soft over the past few years, Banana Republic has improved quite a bit this year, and Old Navy has been quite strong. Both for price point and for quality, Old Navy struck a good cord. They are not moving down to the apathetic customer who only cares about price, but they definitely have an original customer who maybe was not as interested in shopping before on the men's side of the business. So that is a little stronger than expected. The men's business in the Gap stores has been soft for the past few years, but also there are quite a lot more stores in the mall now selling merchandise that looks like the old Gap concept of men's merchandise. They made some efforts from a merchandising standpoint in the Fall to directly address the "go to work casual" look. The merchandise was there, but they did not complete the look with the advertising. The advertising which was a variant on image advertising got people's attention but did not drive them to the store to buy haberdashery clothes for men. It was not product specific. It was not appropriate in terms of the emphasis and they have a new head of advertising who has been on board since August and they think we will see that image be more direct than inferred. They think that should hopefully help drive people to understand what they have in the stores which they think looks better than it did a year ago. They think there are pieces of the assortment that are still being tinkered with but there are core things that will appeal to men who are less interested in fashion elements and are more interested in the predictability of going into a store and finding things they are used to. The women's business is great. The kid's business is incredible, particularly baby now. They have very young layette and newborn things. They have had very few misses and have been very lucky in terms of their merchandise selections. Basics, denim, kids, etc. have all sold well. The impact on margins has come from better acceptance from Old Navy brands and better sourcing.

OUTLOOK FOR HOLIDAY THIS YEAR. They made a decision which they have not fully evaluated yet, to flow Fall merchandise later than last year when they heard a lot of comments about people not wanting to buy Fall clothes in July and August. And, it was less successful than they thought but they don't know whether that was timing or just the merchandise. They think that with holiday their goal was to make sure that they weren't too early out there with the colors and that they had some newness in the schedule on an ongoing basis -- don't put everything in the store on the first of November and then have nothing new in the store right after Thanksgiving. Currently they have holiday merchandise in the stores. They are flowing some holiday merchandise later this year which explains in part the inventory levels at quarter end. They will have additional holiday flow just before and just after Thanksgiving. They encouraged people to go to the stores and take a look. They think the bright colors are nice. With regard to Fall, they confused it a little bit. They delayed it then they moved it back up and parts got moved up a full week and parts didn't. For holiday they are trying to keep some newness in the assortment and distinguish it from the October markdowns.

INTIMATE APPAREL. They are very happy with the intimate apparel merchandise they have been testing. It has been in 30 stores for Gap and will be in 75 stores during the holiday season nationally. There are a couple of things about this business. One of the things is that the little funny containers they had it in were a little awkward for the customer to work with and were demanding on their staff in the stores. So the merchandise has been repackaged and they think it works best in stores where it is paired with the personal care and the fashion merchandise. It looks best in an environment which is predominantly a female environment. They are very pleased with the sales productivity and the margin on the items though.

WHAT NUMBER OF STORES IS SATURATION LEVEL? The company was asked about the number of stores and saturation. The company responded that some people say that at this level of chains the maximum is 500 stores or 1000 stores, etc. Over the years they have seen internally that they keep ramping up the potential as they learn more about the business and find ways to go into markets that they maybe thought were too small before, as they change the content of the merchandise and evolve. They indicated that if we saw the maximum number of stores they projected internally even 5 years ago, we would laugh at it given where we think they can go today. So, they don't put any finite top on the numbers of stores any more.

SHARE BUYBACK IS PART OF GROWTH STRATEGY. They think growth trends may have been a subject of some confusion when they announced their new share buyback program a couple of weeks ago. Some people tend to think of share buybacks as the opposite of growth. The Gap thinks that is absolutely untrue in their case. A permanent investment continues to be and will be going forward, the growth of their brand. They have high class problem, though. It doesn't take a lot of money to invest in stores and they continue to increase the amount of money they spend there, but they generate a lot of cash. They happen to make money in their businesses and they throw off cash and they cannot use it in their existing businesses as quickly as they would like. So, they think a share buyback program complements the growth of their existing businesses and brands. It is also a strategy that returns additional value to shareholders and they want to continue that. So they announced a couple of weeks ago an additional 30 million shares (about 11% of the outstanding shares) that will be bought over the next 3 years.

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