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., August 19, 1996/FOOLWIRE/ --- The Gap reported Q2 1996 earnings Thursday morning, August 15th. Sales were up 29% to $1.12 billion compared to $869 million in last year's Q2. Their earnings per share were $0.23 versus $0.11 a year ago, which was 109% increase over a year ago.

The comps for the quarter were up 9% versus a negative 4% last year. In the quarter, by division, both Gap and Gap Kids were positive low double digits, Banana Republic was a positive high single digit. They do not yet break out comps for their Old Navy business, but it continues on the pace it had in Q1 -- exceeding plan quite handily. For the second quarter in a row, productivity in terms of sales per square foot continued to improve. A few years ago, as they began to expand the size of their stores, sales per square foot was beginning to decline. This year, they are very happy with the fact that their sales, especially because of new categories and good response to apparel, are up to $96 this quarter versus $88 a year ago.

Reported margins, net of occupancy were 35.7% for Q2 1996, 580 basis points above last year's 29.9%. The substantial increase in gross margin is due to a combination of merchandise margins and occupancy cost being a bit lower (the split was about 2/3 merchandise margins and 1/3 occupancy). The margin increase was driven primarily by an increase in initial margins and was coupled with very strong regular price sell-through, in fact the strongest regular-price sell-through in 6 years. Slightly more than half of the improvement in merchandise margins is due to higher initials. Last year's Q2, coming off the record 1994 Q2, was a substantial decline from 1994, so they had a down year followed by a good up year. They also got a boost from occupancy costs which were about 200 basis points lower as a percent of sales. This is primarily due to the very strong comparable store sales. Old Navy's lower occupancy costs also help the year-to-year comparison.

Operating expenses increased 220 basis points from 24.2% a year ago to 26.4% this year. There were three primary reasons. The first was bonus expense, which increased about 100 basis points due to strong year-to-date earnings performance against their annual targets (note -- both in Q2 and in the first half of last year they accrued no bonus). They also spent more on advertising and marketing across all their brands, which was about 70 basis points of the increase. Lastly, since earnings were so strong in the quarter, they wanted to share some of that so they made an additional contribution to their Gap Foundation of $5 million in Q2.

Interest was $4 million -- that number will be about the same for the next couple of quarters. The tax rate was unchanged at 39.5%. They have been at the same tax rate for about 3 years. They usually review it in Q2, and are not changing it for the balance of the year. Their pre-tax return on sales was 9.7% versus 6.2% a year ago. Return on equity for the trailing four quarters is 26.5%. Q2 net earnings increased 103% to $66 million, from $32 million a year ago -- a new Q2 record and 50% above the previous best of $44 million in 1994. Weighted average shares reflects a stock buyback and their stock split announced earlier in the year. After tax return on sales was 5.9%.

The Gap was very happy with their Q2 earnings results. They were, in Q2 and the first half, facing the easiest prior year comparisons. The company obviously set out to beat them and did much better, substantially beating even 1994's numbers on an earnings per share basis. They continue to focus on long-term growth of the brands -- all of their divisions had improved sales and margins over Q2 last year.

For the first half, sales were up 30% to $2.233 billion. Year-to-date comps were also up 9% versus a negative 3%. Reported margins net of occupany were up more than 500 basis points. The increase was, again, due to higher merchandise margins and about 200 basis points in occupancy expense improvement. Operating expenses for the year-to-date period are up 190 basis points year-over-year for the same reasons cited for Q2. Pre-tax is 10.9% for the first half. Net earnings increased 79% to $147 million, or 6.6% of sales compared to $83 million a year ago. Earnings per share for the first half were $0.51 per share versus $0.28 last year, an 82% improvement. As with Q2, for the first half, all the divisions were profitable and achieved increased earnings over last year.

BALANCE SHEET

Cash and investments, both short and long-term investments, were at $642 million at the end of the quarter versus $400 million a year ago. They are essentially debt-free. They have local currency borrowings at the end of Q2 of about $67 million, done to support their international operations. That is the only debt they have.

Not surprising given the very strong sales performance in the quarter, they ended with inventory up only 13% in total -- below plan. Markdowns are about the same as a year ago in terms of percentage. The cost of inventory per square foot is down 4% compared to a year ago -- the lowest level of inventory per square foot in 6 years. Fall merchandise is currently in the stores -- for Gap and Gap Kids it flowed in last week. The stores look terrific and there is a lot of interesting new product out. They are very pleased to not only be growing sales and earnings, but doing it in a balanced way -- managing inventory, managing for return on invested capital. Of note, for the first time ever they exceeded a $1 billion in net fixed assets at the end of the quarter.

Capital expenditures year-to-date are about $145 million net of disposals. Last year at this time it was $136 million. Depreciation and amortization year-to-date is $94 million versus $81 million a year ago. For forecast purposes, the full year number for depreciation and amortization is about $190-200 million.

In terms of cash, it is their preference always to reinvest it in the business. They are doing that. They are not constrained in terms of reinvesting in their businesses. They also pay dividends. Dividends were increased in Q1 by 25%. Another way to return value to shareholders is buy back stock. During Q2 they repurchased approximately 4.5 million shares of stock totalling about $138 million. Also, they noticed that the stock got a little soft in terms of its price during the quarter and took advantage of that. Cumulatively, since they announced the program to buy back 18 million shares in October 1994, they have acquired 13.1 million shares at just under $300 million in cost. So they are well on their way to accomplishing that buyback.

They opened 48 new stores in the quarter, closed 10, and expanded 12. They had a net increase in square footage year over year of 18%. They ended with just under 12 million square feet and 1756 stores. The total number of international stores was 183 at the end of Q2, or roughly 10% of the total. They will open between 175-200 stores this year. The square footage growth before accounting for any closed stores should be about 15% for the full year.

LOOKING FORWARD AT THE SECOND HALF OF 1996

For the second half of 1996, their goal continues to be sales growth of 15-20% which implies, given square footage, mid-single digit comps. For the second half of 1995, despite the easier comparison in August, their comps last year were a positive 2% versus negative comps in the first half. So their second half comparisons are, at least on the surface, more challenging than the first half. They aren't less optimistic about their prospects for the back half of the year, they just want to remind people that you can't extrapolate the momentum they had in the first half and expect them to duplicate it number for number in the back half and they also wanted people to remember that the results for the first half of 1996 are the highest that they have had in 5 years. They wanted people to be realistic about what the comparisons are. They still see opportunity for margin improvement in the last half of the year even though the comparisons are not as easy as the first half.

They are entering Q3 with initial margins higher than a year ago. Hopefully they can convert that to better maintain margins with regular-price selling. Their focus will be on regular-price selling in the last half of the year. Last year's second half was a record in terms of sell-through percentage.

If they get modest comp growth in the last half and leverage from Old Navy, occupancy cost for the full year should be slightly lower than a year ago. If they get mid-single digit comps in the back half, SG&A for the full year will increase slightly. It will probably be flat compared to last year in the back half. They need to continue to deliver in the second half of the year, but are confident that they are set up to do that and are optimistic.

They think of the business as a portfolio of brands. Their opportunities for growth come from developing those brands. There are many examples -- in The Gap, as part of the new Fall rollout, some of the stores have jewelry, paper goods, sunglasses, the new Gap Sport line of personal care products, women's intimite apparel. In terms of Gap Kids, baby bedding, picture frames, gifts, etc. Old Navy has some CDs, soon to get personal care, gadgets, other stationery products, etc.

SPECIAL SEGMENT ON THE BANANA REPUBLIC ORGANIZATION

This quarter they featured a special segment to discuss some of the progress they have been making at Banana Republic in defining its role in the portfolio of brands called Gap Inc., the business opportunity that corresponds to that role, and how they are going to capitalize on that business opportunity.

When they started to look at Banana Republic a year ago, they felt it had an identity crisis and that is what they are setting out to fix. The first Banana Republic catalog went out in 1978. The organization spent its first ten years "on vacation" -- very hearty adventures, safaris, faraway places, mystical adventures. Then, in 1989 faced with flagging sales, the company embarked on a multi-million dollar campaign to rennovate and modernize stores and the face of Banana Republic. They took the brand at that point to a very outdoors-y point of view. That was followed by a focus on growing the women's business and then that was followed by a focus on growing the fashion point-of-view of the business. Then, a little bit of a switch took them back to focusing on the heritage of the business and the classics on which the business was based. Then that phase was followed by a focus on product extensions that had nothing to do with the heritage, but were a whole new line of personal care products.

They did some preliminary customer research to measure how bad the Banana Republic identity crisis was. The good news is that they found out that the crisis wasn't terminal, that while they were confused, the consumers had a very soft spot in their heart for the brand called Banana Republic. This brand had very high approval ratings and very low negative ratings. So their challenge has not been to reinvent the Banana Republic brand, but to build it. The first challenge is to help the organization understand the difference between a product and a brand -- tough for retailers because they spend their life focusing on delivering products, so focusing on delivering branded products becomes a different mindset.

They defined the issues that products have economic value. The customer needs a pair of pants, they can go buy those pants anywhere. It addresses a business opportunity that is a point in time. And whether it is cargo pants because that is the particular time or jeans because someone is ready to go back to school, or chinos because they have a date on Saturday night, it happens to address the particular need at a particular point in time -- that's the product focus. A brand, however, addresses a specific customer. It speaks to that specific customer and transforms the mere product by adding emotional value. So they take economic value and have added emotional value. A powerful brand can shortcut the purchase decision creating loyal customer who will spend more and will spend more, more often. Some brands are so powerful that a single visual image can convey their class, their status, their taste, and everything you ever wanted to know about that person.

So, how do they build the Banana Republic brand? They are basically approaching it the same way they would approach anything else and there are four steps to do that. The first step is to characterize the consumer -- the one to whom they are speaking. The second step is to define the essence of the brand. The third is to identify the specific business opportunity they want to address with the brand. And the fourth is to develop that emotional connection to add the value in defining what that brand is.

Over the course of the last year they have conducted several levels of research that has yielded very rich data about the customer they have, the customer they used to have, and the customer they want to have. To define who the customer is and who they want them to be -- and the good news is that they like the customer they have, it is a very good customer. A high proportion of Banana Republic customers, over 70% have incomes over $50,000 per year, with 32% that have incomes over $100,000. When they go to the attitudes of these customers, they have a very large proportion of customers who call themselves "clothing enthusiasts" -- these are customers who love to shop. They also characterize themselves, secondarily, as "classic" so the company can fairly easily predict the kinds of clothes they are going to buy. The target customer for Banana Republic is a very attractive customer. They are educated, cultured, social, love to shop, love to travel, they are doers and seekers. Their customer is spending and the segment is growing both in numbers and in share of the apparel dollars spent.

Having defined the customer, they had to define the essence of the Banana Republic brand. Brand essence is the soul or heart of the brand and is the total experience from the use the customer gets out of a product, the packaging, the place where the customer bought it, everyone who is associated with the product. Brand essence makes a brand distinctive and makes it unique and it communicates the basic truth and values about the customer. This is valuable to the customer and to the organization in helping define how they set out the stores, approach the marketing, approach sales training. It is also about consistency and that has been a Banana Republic challenge. Part of Banana Republic's essence lies in their past. Their heritage is classic, casual, comfortable, but it is also accessible, unpretentious, and ageless and very adventurous. The other main association that distinguishes Banana Republic is design. They have a 40-person design team in New York. Their women's design team brings leadership from Ann Taylor, Liz Claiborne, Perry Ellis, and very fashion-oriented places in the marketplace. And the men's head of design from Polo Sport. This brings fashion, style, and sophistication as well as quality, versatility and usefulness. They also found a very rich association in the essence of their brand in their stores. They are classic and comfortable. They are casual. They have style and they are sophisticated. Their stores have been the major voice with which they have communicated their new sense of sophistication and style.

When the richness of their heritage is combined with the newness of design, then add the store environment that has a very strong emotional attachment to the customer, they are able to define the Banana Republic brand.

The next issue is the business opportunity. Department stores have really contributed to the issue that brands out there today classify themselves by occasion (a suit to go to work, a pair of jeans for Saturday, and then the "third occasion" which is described as the "Friday thing"). Today, the business opportunity lies in offering a wardrobe that is versatile enough to cross all three of these occasions. They don't believe anyone is crossing all three in a very effective way. If Banana Republic can be the brand that bridges that business opportunity they see tremendous sales out there that match who their customer is that they just identified. The business opportunity is simplicity with style and is an aspirational way of dressing in the 90s. The business opportunity is where the lines of dressing are blurring and where people are searching for the simplicity with style. The business opportunity applies their brand definition, relaxed style, to a one versatile modern wardrobe. That is, in essence, who they are and what they are going to do in one sentence.

The last part is developing that emotional connection with the customer that brings them back time after time. An interesting phenomenon is occuring in the target customer group that is getting a lot of press which is a desire for self-expression. The aspiration of today lies not in identifying with someone else's life but adding net present value to one's own life. The idea is to go climb that mountain today, not hope that you can go climb it when you retire. So net present value is a very important concept in how people look at their lives today. We are also down-aging which is a culture where 60 feels like 45 and 50 feels like 35. There are many elements of who Banana Republic is that are in synch with these aspirations.

They end up with a brand position that states that Banana Republic is the source for versatile modern wardrobe that enables you to be yourself with great personal style.

The next step for Banana Republic is to establish the brand position and personality. They need to establish the brand in the customer's mind through consistent imaging, so they dont flip flop again on who they are. They have to do that in the store, with their products, and in the media. The great thing about a strong brand is that it gives a very loyal customer that shops with you often. It also gives you permission to extend that brand to other products your customers want to buy. Banana Republic is not waiting until they get their imaging out there on their apparel brands to start exercising what the customer has told them they want in terms of brand extensions. They have already established a very successful shoe business. In October they will be launching a new watch line. Also in October they are going to extend their gift offer and have gifts for people of style to give to other people of style. So, they are taking this brand, they've decided who they are, they are extending who they are to what they do, and now they have to extend that to their customer.

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* 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.

(c) Copyright 1996, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool.

Transmitted: 8/19/96 4:09 AM (gps2q96)

Copyright 1996, The Motley Fool
All Rights Reserved. This material is for personal use only.
Republication and redissemination, including posting to news groups,
is expressly prohibited without the prior written consent of The Motley Fool.