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 Street
San Francisco, CA 94105
(415) 952-4400
http://www.gap.com

UNION CITY, CA (March 2, 1997)/FOOLWIRE/ --- Gap, Inc. reported record sales and earnings for both the fourth quarter and fiscal year 1996 on February 27th. Sales in 1996 increased 20% to $5.3 billion compared to $4.4 billion a year ago. Their earnings per share for the year was $1.60 versus $1.23 a year ago, that is a 30% increase and in line with analyst estimates. The three-year CAGR in earnings per share is 22%. Sales in the fourth quarter were $1.67 billion, 10% growth over the 14 weeks last year which came in at $1.52 billion. Fourth quarter net earnings increased 11% to $171 million, up from $155 million a year ago. Their earnings per share was $0.62 (also in line with analyst estimates) compared to $0.54 a year ago, a 15% increase and a full 4% higher than the net earnings growth due to their opportunistic share buyback in the fourth quarter. Their fourth quarter earnings per share is calculated based on average quarterly shares outstanding while the full year's EPS is based on the average for the entire year. There was one less week this year for both the fourth quarter and the full year, which is something to consider when looking at sales and earnings comparisons.

COMPS & SALES METRICS FOR THE YEAR. Their total company comparable store sales were up 5% for the year versus flat in 1995. All of their divisions experienced positive comp store growth in 1996. The Gap was in low single digits. Gap Kids was in mid-single digits. Banana Republic was in high single digits. Old Navy had an absolutely wonderful year. Their total company sales per square foot increased 4% to $441, up from the $425 per square foot last year. Their reported margins net of occupancy were 37.8% or 200 basis points higher than the 35.8% in fiscal 1995. That 200 basis point improvement was split about equally between higher merchandise margins and lower occupancy costs and the increase in margins is due to higher initial merchandise margins and better regular-price sell-through. A reminder which is important for Gap's outlook for 1997 is that the biggest increases came in the first half of 1996 in margins. Those levels were also above the record levels of 1991.

COMPS & SALES METRICS FOR THE QUARTER. The comparable store sales growth 13 weeks on 13 weeks is 3% versus 4% last year. In the fourth quarter, Gap was negative low single digits, Gap Kids was positive low single digits, Banana Republic was positive mid-single digits, and Old Navy's business continued very strong. Sales per square foot in the quarter were flat at $132. Their reported margins in the quarter, net of occupancy increased 60 basis points to 38.4% from last year's 37.8%. All of the increase came from higher merchandise margins. The increase in margins was primarily due to better regular-price sell-through and slightly higher initial margins. Operating expenses as a percent of sales increased 50 basis points to 21.8% from 21.3% a year ago. This increase is primarily attributable to planned increases in advertising costs, particularly for the Old Navy division. After-tax return on sales is 10.3% versus 10.2% a year ago in the fourth quarter. All divisions were profitable in the fourth quarter.

SPENT MORE IN ADVERTISING, AS PLANNED. Operating expenses increased 110 basis points from 22.9% last year to an even 24% this year. The biggest contributors to the increase were, as they talked about before, they planned to spend and did spend more on advertising and marketing of their brands. The total advertising and marketing was about 1.7% of sales or 30 basis points more than last year. In 1995 advertising and marketing was about 1.4% of sales. Over the last 10 years, it has averaged about 1.2-1.3% of sales with some variation year to year. They have historically spent more than other specialty apparel retailers on advertising, but far less than consumer-branded companies. They think that part of the increase is a reflection of the growing Old Navy business as a percentage of their total business. Old Navy's advertising has, from day one, been at a higher percent of sales than what they have done with the forecast brands as well as Banana Republic.

WILL RAMP UP ADVERTISING FOR BANANA & GAP. Also, within Banana Republic and Gap, they are going to be ramping up that spending somewhat. They want to be really careful about this -- they think advertising and marketing are really important but difficult to measure the benefits. They aren't going to do it without evaluating it and will do it carefully and thoughtfully. Some of the things like they did in the fourth quarter with a small amount of television for Baby Gap are not inexpensive compared to the print ads they have done in the past, but was very successful. So, for the corporation, they will be approaching and exceeding that 2% of sales number this year.

IMPACT ON OP EX FROM BONUSES. Also, about 50 basis points of the increase in operating expenses was attributable to bonus expense which had two components -- the one they have been talking about all year long which is an above-target payout or management bonus (they paid very little in 1995, this is tied to the results of the corporation). Also they are paying a special all-employee bonus to full-time and part-time employees based on meaningfully beating their earnings growth targets internally. They did a similar payout in 1994 and 1993 as a way to recognize employees for their role in Gap's success.

OTHER INCOME STATEMENT RESULTS. Interest income increased to $19.5 million from $15.8 million a year ago. The tax rate was 39.5% in both years. Their net earnings increased 28% to $453 million from $354 million a year ago. This represents the fourth consecutive year with double-digit earnings growth. After-tax return on sales was 8.6% versus 8.1% a year ago. Their return on equity was 27.5%, up from 23.5% a year ago.

ALL DIVISIONS BUT INTL. PROFITABLE. All of their divisions except international were more profitable in 1996 than last year. International returns reflect the first full year of operating in Germany and Japan. Directionally, their Gap and Gap Kids businesses were above the total company pre-tax return on sales. Their other divisions were below the company total range. Banana Republic was low double digit operating margins, Old Navy was around 10%, and international was still in the high single digits. They are very pleased with the results which demonstrate the strength of their balanced portfolio of apparel brands. It was a pretty good year, more than making up for 1995's weakness.

OLD NAVY DETAILS. Their goal for Old Navy was to get in the high single-digit range on profits. Obviously Old Navy had an outstanding year in 1996, reaching 10%, with tremendous consumer acceptance. The key in their opinion on Old Navy is being able to maintain that level of profitability over time. When they set the business plan and talked about the target of high single-digits they said that the tentative group they sent out in terms of Old Navy's target had never achieved and attained high single digit operating margins. Many of them or several of them had gotten to the 9% range and then fallen back. They are encouraged by Old Navy reaching that level, but one year does not a long-term brand make and they are going to continue to focus on growing that business in 1997 and see what happens. Given their growth in sales in 1996, they experienced some leveraging on their headquarters expenses. They would expect that they will continue to need to invest in the product side and marketing side for Old Navy, but expect modest leveraging on the headquarters expense. The real key there is going to be what the rate of sales growth is in the future. Old Navy has been envisioned and executed as a lower-overhead business than Gap or Banana Republic and they experienced leverage in 1996, but how much of that is upside going forward remains to be seen. Old Navy was dilutive from a merchandise margin standpoint for the corporation in 1996 and modestly positive from a margin net of occupancy perspective because their lower occupancy costs really help the total company occupancy costs. From an operating margin standpoint, as long as they continue to improve year-over-year, which they did in 1996 vs. 1995, and grow as a percentage of the total sales, they are clearly additive to the total company's operating margin. In 1997, a lot is going to depend on what the mix is for all the divisions. But if Old Navy is at least at the same level of profitability as it was in 1996, it will certainly not be dilutive going forward but they saw a fairly large increase in 1996. They talked about them being in the mid-single-digits last year and to get to the 10% level this year means that it has had probably its biggest impact in 1996 (and within 1996, in the fourth quarter). They do not expect anything of that magnitude going forward. As far as merchandise, everything at Old Navy did well with one exception -- the smaller electronics-oriented gadgets -- and they have minimized it as the year progressed. On the apparel side there was strength in both women's and men's as well as the kids and baby business.

BALANCE SHEET. Cash and investments including the short and long-term investments were at $657 million. That is about $42 million less than last year. That decrease is primarily due to investments in their share repurchase program. Inventory at the end of the year was up about 20% total or $579 million versus $483 million last year. On a per-square-foot basis, it's up about 7% from last year. The increase in inventory is primarily due to increased investments across all of the divisions, something we will see a bit more of throughout 1997, and in part, to timing of receipts. Their end of 1996 balance sheet number is slightly inflated due to some earlier receipts. Their actual buys for the Spring period is not as meaningfully up as 20% total inventory was up at the end of the year. So, now and going forward, the company advised not to read into anything based on a quarter-end number. Just know that they are going to be modestly increasing throughout the year.

INVESTMENT IN INVENTORY. As far as the increased investment in inventory, they are not talking about large percentage gains in inventories, they have been very tight on inventories especially on a dollars per square foot basis over the past several years. They have been relatively flat or down on a dollars per square foot basis despite the growth in their businesses. They are going to do this very selectively. In Old Navy, obviously the size of the stores is driving the additional inventory to some extent. But, primarily they are going to focus on the Gap division where they think certain of their core franchise businesses, particularly on the men's side, have been under-inventoried over the past several years. They have talked about this in the back-to-school period in August where they were really not as much of a participant in that back-to-school business in things like denim as they had historically been known for. There are other categories on the men's side and some on the women's, and they're not talking about the "edge" fashion here, they are talking about areas where they can do some meaningful business, where the in-stock position has been very tight and they need to make more of an impact to the customer. They are doing this very selectively after careful analysis of the departments where they have perhaps cut back in order to allow other products like personal care to take space in the store and we will see this in modest ways throughout the year.

QUESTION ON MEN'S CLOTHING SELECTIONS. The company was asked if the inventory level change represented a change in the more "fashion" oriented direction their men's clothing had taken over the last year, back to more basic items. They responded that they don't think they are really talking about that type of change. They don't think, first of all, that men buy fashion to the same extent that women do. They think that there are a combination of things being attempted here and we will see them more in the last half of the year. One of these is, in certain parts of their business, there are products that they have been known for on the men's side (whether they are polo shirts, khakis, or denim) where the merchandise has been all over the place -- lower inventory levels, changing the flashers on the jeans, changing sizing, changing style names and fits -- and they think this has been confusing to customers. To the extent that they are talking about men customers, men are easily confused anyway as shoppers. The Gap is really focusing on not just putting more inventory in or not just putting in more basic items, but they are focusing on the whole package -- in-store signage, the staff being knowledgeable about that part of the business, making sure they aren't out of stock on sizes, etc. This is something they used to be known for, but when you look at trying to run inventories relatively lean you run the risk of disappointing customers who have very low tolerance for service levels being not what they are used to. They think that they will have some fashion on the men's side as well, but they don't think there is a major trend and they don't plan to be more "edgy" or "hip" on the men's side -- just more consistent, easy to read, easy to shop, and in stock. They are not walking away from haberdashery, but will be more selective to match the in-store selection to their audience in individual stores.

QUESTION ON INVENTORY RELATIVE TO GAP KIDS & ELSEWHERE. The company was asked if there would be changes to the inventory at Gap Kids or Baby Gap. They responded that they don't think we will meaningfully see increases in the Kids inventory levels. They are okay in terms of the overall inventory levels. They may focus a little differently as the mix changes to more freestanding Baby stores. If they add 40 freestanding Baby stores that will put them at nearly 78 stores by the end of next year and so, in that sense, they will be shifting the emphasis a little bit but they don't see any major holes on the Kids line in terms of under-investment of inventory. In terms of editing other than that in the corporation, there are some categories of merchandise where they focused in 1996, as part of just testing what they could do in product extensions, which have been less successful and more distraction and they are eliminating those. Examples include the paper goods, jewelry, sunglasses and things like that that take up space, have a higher service level because of locked cases, and detract from their primary focus on apparel. Some of that will free up some space and inventory investment dollars for some of the investments they want to make.

FIXED ASSETS. On the capital side, their capital expenditures for the year including lease rights were approximately $359 million net of disposals. Last year they were $291 million. Depreciation and amortization of fixed assets was approximately $54 million in the fourth quarter, $196 million for the entire year. Last year those numbers were $45 million and $171 million respectively.

SHARE REPURCHASE. During the year they repurchased approximately 16 million shares of their stock for about $469 million. 4.8 million shares were acquired in the fourth quarter at a cost of about $144 million. They were very opportunistic on price weakness. Don't build in that sort of rate every quarter going forward for financial models, but given the softness in the stock price, they decided to take advantage of it. In the fourth quarter, the board authorized a new share repurchase program for 30 million shares over the next 3 years. This follows the completion in the third quarter of an earlier share repurchase program by the company for 18 million shares.

STORES, SQ. FOOTAGE, & EXPANSION PLANS. They opened 203 new stores in 1996, closed 30 stores and expanded the size of 42 existing stores for a net increase in square footage of 14%. At the end of the year they had 12.6 million square feet -- 938 stores in Gap at 6.2 million square feet, 497 Gap Kids stores at 2.1 million square feet, 226 Banana Republic stores at 1.4 million square feet, and 193 Old Navy stores at 2.9 million square feet. That is a total of 1854 stores for the corporation. Those numbers include the international stores which totalled 209 or about 11% of the total at the end of the year. Looking at capital spending at store openings planned for 1997. Their capital expenditures will be increasing and should be in the range of $400-450 million. They plan on opening at least 275 stores in 1997, an acceleration from the 203 in 1996. Their new square footage growth should be about 18% before closings. They expect it to break down as follows: Gap division with 70 stores, Gap Kids with 70 stores and 40 of those being Baby only stores, Banana Republic with 30 stores, another 30 stores in the international division, and up to 75 stores for Old Navy. For international expansion, the new stores will be concentrated primarily on Japan and the UK. They have a handful of stores on board for both France and Germany, but of the 30, 15-20 will be in Japan and the UK and they are all Gap and Gap Kids stores. In virtually all cases, when they have a location there will be both a Gap and a Gap Kids store at that location. Of the 30, they will break out roughly 50/50 between Gap and Gap Kids.

COMMENTS ON INTERNATIONAL EXPANSION. Japan had a decent year in 1996 and it is first full year of operation. They actually made a small amount of money in 1996 there which they think is incredible having done this on their own. Obviously it was well below the profitability of the other businesses yet, but to be above the break-even line is a tribute to the team over there. Germany, on the other hand is a little more problematic. They have a very small base there and it is a very fragmented market. The early results have been okay but not great. They are being very cautious in Germany in terms of how rapidly they roll out until they figure out the profit formula. It is a very difficult market. There are many retailers who have gone in and pulled out. Germany is limited in terms of store opening hours and it is difficult just to operate there. They are being more cautious there, although long-term it is an incredible market -- they spend more on apparel per capita than any country in Europe -- and the Gap is determined to figure that out. In terms of any other brand besides Gap going international, their focus over the near-term is to continue to open Gap and Gap Kids stores and not bring Old Navy or Banana Republic into any other country for the foreseeable future, which could be several years away. They are going to lead with their strongest brand and really build the infrastructure to support that. They believe Banana Republic, particularly with the UK and Japan, has tremendous opportunity. Old Navy has tremendous opportunity internationally. They just don't need to do it yet. There is a lot going on domestically with those businesses, so they are going to wait on taking them outside the US.

OUTLOOK FOR 1997. For the full year, their target in sales is low single-digit comp growth. Given the addition of new square footage, sales in non-comparable stores will be more important in driving earnings in 1997. In terms of productivity, they think that the assumptions people should make in terms of how productive new square footage additions are should be no more than 100% of the square footage. They were very fortunate in 1996 that their new non-comparable square footage was at about 100% of the comp base even with a 5% increase in comps. And, they think that is the first year that has been the case in the last 4-5 years when they started the expansion program. They do not think that it's appropriate to bake into the 1997 forecast. So, their targets have normally been that if they increase square footage in this range, if they have moderate comparable store sales growth over the year, total topline should be in the 16-20% range. That depends on if they get comparable store growth and are those stores 80-90% of the comp base or something better or worse. Comp growth is particularly challenging in the first half of 1997 when they are up against 9% comps versus last year. They will be talking about February sales next Thursday, March 6th. In terms of margins, they have substantial growth in both initial merchandise margins and maintained margin in 1996. They would expect minimal growth in initial margin in 1997. Margin upside will be driven by customer response. Gross margin is going to be higher or lower than last year based primarily on regular-priced sell-through. On operating expenses, these are very likely to increase somewhat in 1997 primarily due to additional investments in advertising and marketing which continue to reinforce and develop the Gap, Inc. brand. It was 1.7% of sales in 1996 and could be up as much as 50 basis points in 1997. A summary on their outlook on 1997 -- a major factor in earnings growth will be total sales growth, topline sales growth.

MANAGEMENT CHANGES. They had some recent management changes and these changes signal a new level of commitment to the core franchise and increasing importance of international growth for the corporation. Announcements made on February 26th are effective June 1st -- three promotions were made at the Banana Republic division. Jeanne Jackson, currently president of Banana Republic has been promoted to CEO of Banana Republic; Marie Holman-Rao, currently executive vice president of Banana Republic, will be promoted to president of the division; and Jerome Jessup, vice president, design director of Women's, will take over as senior vice president of Banana Republic Product and Design. As CEO, Jeanne Jackson will continue to direct all aspects of the 226 store Banana Republic chain. In her role as president, Marie will add merchandising to her continuing responsibility for product development and she will oversee the entire design and development functions including production and planning and she will be moving to San Francisco this Summer. Jerome will take over Holman-Rao's former responsibilities including supervision of all New York-based product development and design staff for Banana Republic.

SUMMARY. They think 1996 was an outstanding year for the Gap. They came back strong in 1996 with strong sales and earnings growth. The share buyback enhanced the earnings per share growth and shareholder value and they expect that is something they will consider on an ongoing basis in 1997 and beyond. They also became more bullish in 1996 on their growth opportunities for all of the brands, which can be seen in their store opening plans. They will also put dollars into marketing those brands more in 1997 with an eye towards continuing to focus on long-term growth in all of their core businesses.

* A Fool conference call synopsis represents an effort to highlight the salient points of a conference call and should not be taken as an authoritative accounting or transcription of the entire event. Note: Statements made by a company other than historical information may constitute forward-looking statements for which the company can claim protection under the Safe Harbor Act. Please consult the company's filings with the SEC for information on risk factors which might cause actual results to differ materially from the information contained in these forward-looking statements.