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Article by DailyStocks_admin    (08-10-08 04:54 AM)

The Daily Magic Formula Stock for 08/10/2008 is Gap Inc. (The). According to the Magic Formula Investing Web Site, the ebit yield is 14% and the EBIT ROIC is 25-50 %.

Dailystocks.com only deals with facts, not biased journalism. What is a better way than to go to the SEC Filings? It's not exciting reading, but it makes you money. We cut and paste the important information from SEC filings for you to get started on your research on a specific company.


Dailystocks.com makes NO RECOMMENDATIONS whatsoever, and provides this for informational purpose only.

BUSINESS OVERVIEW

General

The Gap, Inc. (the “Company,” “we” and “our”) was incorporated in the State of California in July 1969 and was reincorporated under the laws of the State of Delaware in May 1988.

We are a global specialty retailer operating retail and online stores selling casual apparel, accessories, and personal care products for men, women and children under the Gap, Old Navy, Banana Republic, and Piperlime brands. We operate stores in the United States, Canada, the United Kingdom, France, Ireland, and Japan. We also have franchise agreements with unaffiliated franchisees to operate Gap and Banana Republic stores in Asia, Europe and the Middle East. Under these agreements, third parties operate or will operate stores that sell apparel, purchased from us, under our brand names. In addition, our U.S. customers may shop online at www.gap.com, www.bananarepublic.com, www.oldnavy.com, and www.piperlime.com.

We design most of our products, which are manufactured by independent sources, and sell them under our brands:

Gap. Founded in 1969, Gap stores offer an extensive selection of classically styled, high quality, casual apparel at moderate price points. Products range from wardrobe basics such as denim, khakis and T-shirts to fashion apparel, accessories, personal care products for men and women, ages teen through adult, and maternity apparel. We entered the children’s apparel market with the introduction of GapKids in 1986 and babyGap in 1989. These stores offer casual apparel and accessories in the tradition of Gap style and quality for children, ages newborn through pre-teen. We launched GapBody in 1998 offering women’s underwear, sleepwear, loungewear, yoga gear, and personal care products. We also operate Gap Outlet stores, which carry a similar line of products.

Old Navy. We launched Old Navy in 1994 to address the market for value-priced family apparel. Old Navy offers broad selections of apparel, shoes and accessories for adults, children and infants as well as other items, including personal care products, in an innovative, exciting shopping environment. Old Navy also offers a line of maternity wear.

Banana Republic. Acquired in 1983 with two stores, Banana Republic now offers sophisticated, fashionable collections of dress-casual and tailored apparel, shoes and accessories for men and women at higher price points than Gap. Banana Republic products range from apparel, including intimate apparel, to personal care products. We also operate Banana Republic Factory Stores, which carry a similar line of products.

We also offer products that are designed and manufactured by branded third parties in our online shoe store:

Piperlime. We launched Piperlime in October 2006. Piperlime offers customers an assortment of the leading brands in footwear for women, men and kids, as well as tips, trends and advice from leading style authorities.

As of February 2, 2008, we operated a total of 3,167 store locations. For more information on the number of stores by brand and region, see the table in our “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included as Part II, Item 7 of this Form 10-K.

We introduced Gap Online, a web-based store located at www.gap.com, in 1997. Products comparable to those carried in Gap, GapKids, babyGap and GapBody stores can be purchased online, as well as a petite line not found in stores. We introduced Banana Republic Online, a web-based store located at www.bananarepublic.com, in 1999, which offers products comparable to those carried in the store collections, as well as a plus size line not found in stores. In 2000, we established Old Navy Online, a web-based store located at www.oldnavy.com. Old Navy Online also offers apparel and accessories comparable to those carried in the store collections, as well as a plus size line not found in stores.

On February 26, 2007, we announced that we would not move forward with the roll-out of our Forth & Towne brand. While we were encouraged by the initial performance of Forth & Towne, a thorough analysis revealed that the concept was not demonstrating enough potential to deliver an acceptable long-term return on investment. We closed all 19 Forth & Towne stores located in 10 U.S. markets by the end of June 2007.

Certain financial information about international operations is set forth under the heading “Segment Information” in Note 16 of Notes to Consolidated Financial Statements included in Part II, Item 8 of this Form 10-K.

Our stores offer a shopper-friendly environment with an assortment of casual apparel and accessories that emphasize style, quality and good value. The range of merchandise displayed in each store varies depending on the selling season and the size and location of the store.

Our stores generally are open seven days per week (where permitted by law) and most holidays. All sales are tendered for cash, personal checks, debit cards, or credit cards. We also issue and redeem gift cards through our brands.

Gap, Banana Republic, and Old Navy each has a private label credit card program and a co-branded credit card program through which frequent customers receive benefits. Private label and co-branded credit cards are underwritten by a third-party financing company.

Merchandise Vendors

We purchase merchandise from approximately 790 vendors with facilities in approximately 60 countries. No vendor accounted for more than 3 percent of the dollar amount of our total fiscal 2007 purchases. Of our merchandise sold during fiscal 2007, approximately 3 percent of all units (representing approximately 3 percent of total cost) were produced domestically while the remaining 97 percent of all units (representing approximately 97 percent of total cost) were produced outside the United States. Approximately 22 percent of our total merchandise units (representing approximately 24 percent of total cost) were produced in China, with the remainder coming from approximately 60 other countries. Any event causing disruption of imports from China or other foreign countries, including the imposition of additional import restrictions, could have an adverse effect on our operations. Substantially all of our foreign purchases of merchandise are negotiated and paid for in U.S. dollars. Also see the section entitled “Risk Factors—Trade matters may disrupt our supply chain” in Item 1A of this Form 10-K.

Seasonal Business

Our business follows a seasonal pattern, with sales peaking over a total of about 13 weeks during the back-to-school (August) and holiday (November through December) periods. During fiscal 2007, these periods accounted for approximately 32 percent of our net sales.

Brand Building

Our ability to develop and evolve our existing brands is a key to our success. We believe our distinct brands are among our most important assets. With the exception of Piperlime, virtually all aspects of brand development from product design and distribution, to marketing, merchandising and shopping environments are controlled by us. With respect to Piperlime, we control all aspects of brand development except for product design. We continue to invest in our brands and enhance the customer experience through the remodeling of existing stores, the closure of under-performing stores, and a focus on customer service.

Advertising

We place print ads in major metropolitan newspapers and their Sunday magazines, major news weeklies and magazine categories such as lifestyle and fashion. Our ads also appear in various outdoor venues, such as mass transit posters, exterior bus panels, bus shelters and billboards, and indoor venues, such as in-mall kiosks. We also advertise online as well as run television and radio ads for certain brands. We plan to continue our investments in advertising and marketing in fiscal 2008. There can be no assurances that these investments will result in increased sales or profitability.

Trademarks and Service Marks

Gap, GapKids, babyGap, GapBody, Banana Republic, Old Navy, and Piperlime trademarks and service marks, and certain other trademarks, have been registered, or are the subject of pending trademark applications with the United States Patent and Trademark Office and with the registries of many foreign countries and/or are protected by common law.

Franchising

We have franchise agreements with unaffiliated franchisees to operate Gap and Banana Republic stores in Bahrain, Indonesia, Kuwait, Malaysia, Philippines, Oman, Qatar, Saudi Arabia, Singapore, South Korea, Turkey, United Arab Emirates, Greece, Romania, Bulgaria, Cyprus and Croatia. Under these agreements, third parties operate or will operate stores that sell apparel, purchased from us, under our brand names. While we expect that this will be a small part of our business in the near future, we plan to continue to increase the number of countries in which we enter into these types of arrangements over time as part of our efforts to expand internationally. For additional information on risks related to our franchise business, see the section entitled “Risk Factors—Our efforts to expand internationally through franchising and similar arrangements may not be successful and could impair the value of our brands” in Item 1A of this Form 10-K.

Inventory

The cyclical nature of the retail business requires us to carry a significant amount of inventory, especially prior to peak selling seasons when we and other retailers generally build up our inventory levels. We review our inventory levels in order to identify slow-moving merchandise and broken assortments (items no longer in stock in a sufficient range of sizes) and use markdowns to clear merchandise. Because we do not carry much replenishment inventory in our stores, much of our inventory is maintained in distribution centers. Also see the section entitled “Risk Factors—We must successfully gauge fashion trends and changing consumer preferences to succeed” in Item 1A of this Form 10-K.

Competitors

The global specialty apparel industry is highly competitive. We compete with national and local department stores, specialty and discount store chains, independent retail stores and internet businesses that market similar lines of merchandise. We are also faced with competition in European, Japanese and Canadian markets from established regional and national chains. Also see the section entitled “Risk Factors—Our business is highly competitive and depends on consumer spending patterns” below in Item 1A of this Form 10-K.

Employees

As of February 2, 2008, we had a work force of approximately 150,000 employees, which includes a combination of part- and full-time employees. We hire temporary employees primarily during the peak back-to-school and holiday seasons.

To remain competitive in the apparel retail industry we must attract, develop and retain skilled employees, including executives. Competition for such personnel is intense. Our success is dependent to a significant degree on the continued contributions of key employees. Also see the section entitled “Risk Factors—We must successfully gauge fashion trends and changing consumer preferences to succeed” below in Item 1A of this Form 10-K.



Available Information

We make available on our website, www.gapinc.com, under “Investors, Financials, SEC Filings” free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports as soon as reasonably practicable after we electronically file or furnish such materials to the U.S. Securities and Exchange Commission (“SEC”).

Our Code of Business Conduct, Board of Directors Committee Charters (Audit and Finance, Compensation and Management Development, Governance, Nominating and Social Responsibility Committees), and Corporate Governance Guidelines are also available on our website. The Code of Business Conduct can be found at www.gapinc.com, under “Investors, Corporate Compliance, Code of Business Conduct.” Any amendments and waivers to the code will also be available on the website. The Committee Charters and Governance Guidelines can be found on our website under “Investors, Governance.” All of these documents are also available in print to any stockholder who requests them.

CEO BACKGROUND

Michelle Banks , 44, effective March 31, 2008, Senior Vice President, General Counsel, Corporate Secretary and Chief Compliance Officer; Senior Vice President and General Counsel from November 2006 to March 31, 2008; Vice President from March 2005 to November 2006; Associate General Counsel from February 2003 to March 2005; Senior Corporate Counsel from January 1999 to February 2003.

Donald Fisher , 79, Founder; Chairman Emeritus since 2004; Chairman of the Company from 1969 to 2004; Chief Executive Officer of the Company from 1969 to 1995.

Marka Hansen , 53, President, Gap North America since February 2007; President of Banana Republic from June 2003 to February 2007; EVP of Gap Adult Merchandising from February 2002 until June 2003; SVP of Human Resources from March 2000 until February 2002; SVP of Merchandising, International Division from April 1995 to March 2000, VP of Merchandising from April 1990 to April 1995.

Glenn Murphy, 46, Chairman and Chief Executive Officer since August 2007; Chief Executive Officer of Shoppers Drug Mart Corporation, Canada’s largest retail drug store group, from 2001 to 2007.

Art Peck , 52, Executive Vice President, Strategy and Operations since May 2005; Acting President, Gap Inc. Outlet since February 2008; Senior Vice President of The Boston Consulting Group, an international strategy and general management consulting firm, from 1982 to May 2005; Director of The Boston Consulting Group from 1988 to 2005.

Eva Sage-Gavin , 49, effective April 1, 2008, Executive Vice President, Human Resources, Communications and Corporate Social Responsibility; Executive Vice President, Human Resources and Communications from February 2007 to April 2008; Executive Vice President, Human Resources from March 2003 to February 2007; Senior Vice President, Human Resources of Sun Microsystems, Inc. from 2000 to 2003.

Lauri Shanahan , 45, Executive Vice President, Chief Legal and Administrative Officer, Chief Compliance Officer and Corporate Secretary since November 2006; Executive Vice President, Chief Compliance Officer, General Counsel and Corporate Secretary from May 2005 to November 2006; Executive Vice President, General Counsel and Corporate Secretary from December 2004 until May 2005; Senior Vice President, General Counsel and Corporate Secretary from 2001 to 2004. We announced that Ms. Shanahan will be leaving the Company effective March 31, 2008.

Sabrina Simmons , 44, Executive Vice President and Chief Financial Officer since January 2008; Executive Vice President – Corporate Finance from September 2007 to January 2008; Senior Vice President—Corporate Finance and Treasurer from March 2003 to September 2007; Vice President and Treasurer from September 2001 to March 2003.

Michael Tasooji, 51, Executive Vice President and Chief Information Officer since October 2003; Senior Vice President and Chief Information Officer of The Walt Disney Company from 2000 to 2003.

MANAGEMENT DISCUSSION FROM LATEST 10K

OVERVIEW

We are a global specialty retailer operating retail and online stores selling casual apparel, accessories, and personal care products for men, women, and children under the Gap, Old Navy, Banana Republic, and Piperlime brands. We operate stores in the United States, Canada, the United Kingdom, France, Ireland, and Japan. We also have franchise agreements with unaffiliated franchisees to operate Gap and Banana Republic stores in Asia, Europe and the Middle East. Under these agreements, third parties operate or will operate stores that sell apparel, purchased from us, under our brand names. In addition, our U.S. customers can shop online at www.gap.com, www.bananarepublic.com, www.oldnavy.com, and www.piperlime.com. We design virtually all of our products, which are manufactured by independent sources, and sell them under our brands. We also offer products that are designed and manufactured by branded third parties in our online shoe store, Piperlime, which was launched in October 2006.

Fiscal 2007 and 2005 had 52 weeks versus 53 weeks in fiscal 2006. Net sales numbers for the fourth quarter and year for fiscal 2006 include this additional week; however, comparable store sales calculations exclude the 53rd week.

Significant financial items during fiscal 2007 include:


•

Net sales for fiscal 2007 were $15.8 billion compared with $15.9 billion in fiscal 2006, and comparable store sales decreased 4 percent compared with a decrease of 7 percent last year.


•

Net earnings from continuing operations for fiscal 2007 increased 7 percent to $867 million, or $1.09 per share on a diluted basis, compared with $809 million, or $0.97 per share on a diluted basis for fiscal 2006.


•

In February 2007, we announced our decision to close our Forth & Towne store locations. We eliminated about 550 Forth & Towne positions and closed all 19 stores by the end of June 2007. Forth & Towne is presented as a discontinued operation in the accompanying Consolidated Financial Statements. We recorded a loss from the discontinued operation of $34 million, net of income tax benefit, in fiscal 2007 and we expect future charges to be immaterial.


•

As part of our efforts to streamline operations, we examined our organizational structure to ensure that we were enabling our brands to make decisions and effect change more efficiently. These cost reduction initiatives resulted in $34 million of expenses in fiscal 2007, of which $32 million were operating expenses and $2 million were cost of goods sold and occupancy expenses. The majority of these expenses were related to severance benefits for employees at our headquarter locations.


•

Net earnings for fiscal 2007 were $833 million, or $1.05 per share on a diluted basis, compared with $778 million, or $0.93 per share on a diluted basis for fiscal 2006. Included in net earnings for fiscal 2007 was $68 million, or $0.07 per share on a diluted basis, related to the discontinued operation of Forth & Towne and expenses associated with our cost reduction initiatives described above.


•

Our online sales for fiscal 2007 increased 24 percent to $903 million, compared with $730 million for fiscal 2006.


•

We generated cash flows from operating activities of $2.1 billion during 2007. During the third quarter of fiscal 2007, we paid $326 million related to the maturity of our 6.90 percent notes payable. Our capital expenditures in fiscal 2007 were $682 million.


•

In fiscal 2007, we generated free cash flow of $1.4 billion compared with free cash flow of $678 million in fiscal 2006. Free cash flow is defined as net cash provided by operating activities less the purchase of property and equipment. For a reconciliation of free cash flow, a non-GAAP financial measure, to a GAAP financial measure, see the Financial Condition section in this Management’s Discussion and Analysis.

•

We repurchased about 89 million shares of our common stock for a total of $1.7 billion under our share repurchase programs in fiscal 2007 which underscores our commitment to return excess cash to shareholders.

In fiscal 2007, we focused on three critical areas to restore the health of the Company: simplifying the business and holding each brand accountable to its priorities, managing our inventory with discipline to enable growth in gross margin and gross profit, and focusing on product and target customers, specifically at Gap and Old Navy. This work helped us increase net earnings and has created the important groundwork for our future. In fiscal 2008, we will focus on four priorities: driving earnings through inventory discipline which supports improved gross margin, continuing cost management, improving return on invested capital, and continuing to focus on product across all brands. We remain committed to returning excess cash to our stockholders through dividends and share repurchases.

In February 2008, we announced that our Board of Directors authorized an additional $1 billion for our share repurchase program and a plan to increase the annual dividend per share by six percent, from $0.32 per share in fiscal 2007 to $0.34 per share in fiscal 2008.

RESULTS OF OPERATIONS

Net Sales

Net Sales by Brand, Region and Channel

Net sales consist of retail sales, online sales and shipping fees received from customers for delivery of merchandise. Outlet retail sales are reflected within the respective results of each brand. Fiscal 2007 and 2005 had 52 weeks versus 53 weeks in fiscal 2006. Net sales numbers for the fourth quarter and year for fiscal 2006 include this additional week; however, comparable stores sales calculations exclude the 53rd week.

Comparable Store Sales

A store is included in comparable store sales (“Comp”) when it has been open at least one fiscal year and the square footage has not changed by 15 percent or more within the past year. A store is included in Comp on the first day it has comparable prior year sales. Stores in which square footage has changed by 15 percent or more as a result of a remodel, expansion, or reduction are excluded from Comp until the first day they have comparable prior year sales. Current year foreign exchange rates are applied to both current year and prior year Comp store sales to achieve a consistent basis for comparison.

A store is considered non-comparable (“Non-comp”) when it has been open for less than one fiscal year or it has changed its square footage by 15 percent or more within the past fiscal year. Non-store sales such as online revenues are also considered Non-comp.

A store is considered “Closed” if it is temporarily closed for three or more full consecutive days or is permanently closed. When a temporarily closed store reopens, the store will be placed in the Comp/Non-comp status it was in prior to its closure. If a store was in Closed status for three or more days in the prior year then the store will be in Non-comp status for the same days in the following year.

Our fiscal 2007 net sales decreased $160 million, or 1 percent compared with fiscal 2006. Fiscal 2006 consisted of 53 weeks, and the additional week contributed approximately $200 million of net sales. Our fiscal 2007 comparable store sales declined 4 percent compared with the prior year. The 3 percentage point difference between net sales and comparable store sales was primarily due to the impact of new stores and a 24 percent increase in online sales for fiscal 2007 compared with fiscal 2006. Overall, our net square footage increased 1.8 percent in fiscal 2007 from the prior year and sales productivity was $376 per average square foot for fiscal 2007 compared with $395 per average square foot in fiscal 2006. We opened 214 new stores and closed 178 stores in fiscal 2007. This includes the conversion of 45 Old Navy Outlet stores to Old Navy, which are reflected in both openings and closings, and the closure of 19 Forth & Towne stores.

Our fiscal 2006 sales decreased $96 million, or 0.6 percent, compared with fiscal 2005. During fiscal 2006, our comparable store sales declined 7 percent compared with the prior year primarily due to our product assortments at the Gap and Old Navy brands which did not perform to our expectations. Our total non-comparable store sales increase was due to the 194 new store openings and the additional week of sales in fiscal 2006. Our overall net square footage increased 2.9 percent over the prior year and sales productivity in fiscal 2006 was $395 per average square foot compared with $412 per average square foot in fiscal 2005. We closed 116 stores in fiscal 2006, mainly for Gap brand.

Comparable store sales percentage by brand for fiscal 2007 and fiscal 2006 were as follows:


•

Gap North America: negative 5 percent in fiscal 2007 versus negative 7 percent in fiscal 2006;


•

Old Navy North America: negative 7 percent in fiscal 2007 versus negative 8 percent in fiscal 2006;


•

Banana Republic North America: positive 1 percent in fiscal 2007 versus flat in fiscal 2006; and


•

International: negative 1 percent in fiscal 2007 versus negative 8 percent in fiscal 2006.

Store Count and Square Footage Outlet stores are reflected in each of the respective brands. We have franchise agreements with unaffiliated franchisees to operate Gap and Banana Republic stores in Bahrain, Indonesia, Kuwait, Malaysia, Philippines, Oman, Qatar, Saudi Arabia, Singapore, South Korea, Turkey, United Arab Emirates, Greece, Romania, Bulgaria, Cyprus and Croatia. We had 68 and 7 franchise stores that were open as of February 2, 2008 and February 3, 2007, respectively.

Cost of Goods Sold and Occupancy Expenses

Cost of goods sold and occupancy expenses include:


•

the cost of merchandise;


•

inventory shortage and valuation adjustments;


•

freight charges;


•

costs associated with our sourcing operations, including payroll and related benefits;


•

production costs;


•

insurance costs related to merchandise; and


•

occupancy, rent, common area maintenance, real estate taxes, utilities, and depreciation for our stores and distribution centers.

Cost of goods sold and occupancy expenses as a percentage of net sales decreased 0.6 percentage points in fiscal 2007 compared with fiscal 2006. Cost of goods sold as a percentage of net sales decreased 1.4 percentage points, or $307 million, in fiscal 2007 compared with fiscal 2006. The decrease was driven primarily by an increase in selling at regular price and a higher margin achieved for marked down merchandise. As a percentage of sales, occupancy expenses increased 0.8 percentage points in fiscal 2007 compared with fiscal 2006.

Cost of goods sold and occupancy expenses as a percentage of net sales increased 1.2 percentage points in fiscal 2006 compared with fiscal 2005. Cost of goods sold as a percentage of net sales increased 1.3 percentage points, or $156 million, in fiscal 2006 compared with fiscal 2005, as product acceptance challenges drove additional promotions and markdowns. As a percentage of sales, occupancy expenses decreased 0.1 percentage points compared with fiscal 2005. The decrease was primarily due to a net decrease in occupancy expenses of $31 million related to the fiscal 2005 amortization of key money paid to acquire the rights of tenancy in France ($50 million) net of a lease accounting adjustment to true-up amounts which were estimated in our fiscal 2004 financial statements ($19 million).

As a general business practice, we review our inventory levels in order to identify slow-moving merchandise and broken assortments (items no longer in stock in a sufficient range of sizes) and use markdowns to clear the majority of this merchandise.

Operating Expenses

Operating expenses include:


•

payroll and related benefits (for our store operations, field management, distribution centers, and corporate functions);


•

advertising;


•

general and administrative expenses;


•

costs to design and develop our products;


•

merchandise handling and receiving in distribution centers and stores;


•

distribution center general and administrative expenses;


•

rent, occupancy, and depreciation for headquarter facilities; and


•

other expense (income).

Included in operating expenses are costs related to store closures and our sublease loss reserve. The following discussion should be read in conjunction with Note 6 of Notes to the Consolidated Financial Statements.

Operating expenses as a percentage of net sales were flat, but decreased $55 million in fiscal 2007 compared with fiscal 2006 primarily due to the following:


•

$97 million in decreased marketing expenses, primarily for Gap and Old Navy; offset by


•

$32 million of expenses, the majority of which were severance payments, recognized in fiscal 2007 as a result of our cost reduction initiatives not included in fiscal 2006;


•

$31 million of income recognized in fiscal 2006 related to the change in our estimate of the elapsed time for recording income associated with unredeemed gift cards not included in fiscal 2007; and


•

$14 million of income recognized in fiscal 2006 related to the Visa/Mastercard litigation settlement.

The remaining decrease is due to lower payroll and other expenses across the organization.

Operating expenses as a percentage of net sales increased 2.2 percentage points, or $333 million, in fiscal 2006 compared with fiscal 2005. The increase was primarily due to:


•

$162 million in increased payroll and related expenses for more employees and merit increases;


•

$84 million in increased marketing and store related activities;


•

$61 million of income recognized in fiscal 2005 as a result of the effect of the sublease loss reserve reversal not included fiscal 2006;


•

$32 million in increased share-based compensation as a result of the adoption of Statement of Financial Accounting Standards No. (“SFAS”) 123(R), “Share-Based Payment”, in the first quarter of fiscal 2006;


•

$26 million in increased impairment of long-lived assets; offset by

•

$31 million of income in fiscal 2006 relating to the change in our estimate of the elapsed time for recording income associated with unredeemed gift cards; and


•

$14 million of income recognized in fiscal 2006 related to the Visa/Mastercard litigation settlement.

Operating margin was 8.3 percent, 7.7 percent, and 11.1 percent in fiscal 2007, 2006, and 2005, respectively. For fiscal 2008, we expect operating margin to be approximately 8.5 percent to 9.5 percent.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

RESULTS OF OPERATIONS

Net Sales

Net Sales by Brand, Region and Channel

Net sales primarily consist of retail sales, online sales, and shipping fees received from customers for delivery of merchandise. Outlet retail sales are reflected within the respective results of each brand. Net sales by brand, region, and channel for the thirteen weeks ended May 3, 2008 and May 5, 2007 are as follows:

Comparable Store Sales

A store is included in comparable store sales (“Comp”) when it has been open at least one fiscal year and the square footage has not changed 15 percent or more within the past year. A store is included in Comp on the first day it has comparable prior year sales. Stores in which square footage has changed by 15 percent or more as a result of a remodel, expansion, or reduction are excluded from Comp until the first day they have comparable prior year sales. Current year foreign exchange rates are applied to both current year and prior year Comp store sales to achieve a consistent basis for comparison.

A store is considered non-comparable (“Non-comp”) when it has been open for less than one fiscal year or it has changed its square footage by 15 percent or more within the past year. Non-store sales such as online revenues are also considered Non-comp.

A store is considered “Closed” if it is temporarily closed for three or more full consecutive days or is permanently closed. When a temporarily closed store reopens, the store will be placed in the Comp/Non-comp status it was in prior to its closure. If a store was in Closed status for three or more days in the prior year then the store will be in Non-comp status for the same days in the following year.

Our net sales for the first quarter of fiscal 2008 decreased $165 million, or 5 percent, compared with the prior year comparable period. Our comparable store sales decreased 11 percent for the first quarter of fiscal 2008. The 6 percentage point difference between net sales and comparable store sales includes the impact of new stores, foreign exchange, and a 21 percent increase in online sales in the first quarter of fiscal 2008 from the prior year comparable period. Overall, our store square footage increased 2.1 percent in the first quarter of fiscal 2008 from the prior year comparable period and sales productivity was $79 per average square foot for the first quarter of fiscal 2008 compared with $86 per average square foot for the prior year comparable period. During the first quarter of fiscal 2008, we opened 33 new stores and closed 23 stores.

Comparable store sales percentage by brand for the first quarter of fiscal 2008 over fiscal 2007 was as follows:


•

Gap North America: negative 7 percent in fiscal 2008 versus negative 4 percent in fiscal 2007;


•

Banana Republic North America: negative 4 percent in fiscal 2008 versus negative 2 percent in fiscal 2007;


•

Old Navy North America: negative 18 percent in fiscal 2008 versus negative 5 percent in fiscal 2007; and


•

International: negative 5 percent in fiscal 2008 versus negative 3 percent in fiscal 2007.

Store Count and Square Footage

Outlet stores are reflected in each of the respective brands in the table above. We also have franchise agreements with unaffiliated franchisees to operate Gap and Banana Republic stores in Bahrain, Indonesia, Kuwait, Malaysia, Philippines, Oman, Qatar, Saudi Arabia, Singapore, South Korea, Turkey, United Arab Emirates, Greece, Romania, Bulgaria, Cyprus, Croatia, and Russia. We had 83 and 13 franchise stores that were open as of May 3, 2008 and May 5, 2007, respectively.

Cost of Goods Sold and Occupancy Expenses

Cost of goods sold and occupancy expenses include:


•

the cost of merchandise;


•

inventory shortage and valuation adjustments;


•

freight charges;


•

costs associated with our sourcing operations, including payroll and related benefits;


•

production costs;


•

insurance costs related to merchandise; and


•

occupancy, rent, common area maintenance, real estate taxes, utilities, and depreciation for our stores and distribution centers.

The classification of these expenses varies across the retail industry.

Cost of goods sold and occupancy expenses as a percentage of net sales decreased 1.5 percentage points in the first quarter of fiscal 2008 compared with the prior year comparable period. Cost of goods sold as a percentage of net sales decreased 3.1 percentage points, or $182 million, in the first quarter of fiscal 2008 compared with the prior year comparable period. The decrease was driven primarily by a higher margin for both regular price and marked down merchandise. As a percentage of sales, occupancy expenses increased 1.6 percentage points in the first quarter of 2008 compared with the prior year comparable period. The increase was driven primarily by costs related to comparable stores.

We review our inventory levels in order to identify slow-moving merchandise and broken assortments (items no longer in stock in a sufficient range of sizes) and use markdowns to clear the majority of this merchandise.

Operating Expenses

Operating expenses include:


•

payroll and related benefits (for our store operations, field management, distribution centers, and corporate functions);


•

advertising;


•

general and administrative expenses;


•

costs to design and develop our products;


•

merchandise handling and receiving in distribution centers and stores;


•

distribution center general and administrative expenses;


•

rent, occupancy, and depreciation for headquarter facilities; and


•

other expense (income).

The classification of these expenses varies across the retail industry.

Operating expenses decreased $92 million, or 8.8 percent, in the first quarter of fiscal 2008 over the prior year comparable period driven by lower store payroll, fewer remodel related expenses as a result of fewer remodels, and lower marketing expenses.

Operating margin was 11.3 percent and 8.6 percent for the first quarters of fiscal 2008 and 2007, respectively.

Interest Expense

For the first quarter of fiscal 2008, we recognized a reversal of $15 million interest expense from the reduction of interest expense accruals resulting primarily from foreign tax audit events occurring in the quarter. The remaining decrease in interest expense for the first quarter of fiscal 2008 compared with the prior year comparable period was due to lower debt levels as a result of the maturity of our $326 million, 6.90 percent notes repaid in September 2007. We anticipate that fiscal 2008 interest expense will be approximately $5 million.

Interest Income

Interest income is earned on our cash, cash equivalents, and short-term investments. The decrease in interest income for the first quarter of fiscal 2008 over the prior year comparable period is primarily due to a lower average balance of cash, cash equivalents, and short-term investments as well as a lower interest rate environment.

CONF CALL

Evan Price

Good morning. This is Evan Price, Vice President of Investor Relations with a report on monthly sales for fiscal May 2008.

Total company net sales were $1.09 billion for the four-week period ended May 31, 2008, down 8% from last year’s sales of $1.19 billion for the four-week period ended June 2, 2007. Total company comparable store sales decreased 14% compared to a 3% decrease for May 2007.

Brand-specific comps for the month were as follows: Gap negative 7% versus negative 7% last year; Banana Republic, negative 5% versus positive 3% last year; Old Navy, negative 25% versus negative 3% last year; International, flat versus flat last year.

Regarding May sales results, we were pleased that total company merchandise margins were significantly above last year. However, sales results were mixed across divisions with Old Navy continuing to present the biggest challenge. Comps in May were strongest in week 3 and weakest in week 1. By region, comp performance was strongest in the South and weakest in the Northeast.

Turning to divisional results for the month, at Gap, traffic was down 12% in the month compared to negative 10% last month. On a comp basis by division, kids and baby performed better than adults, with women’s performing better than men’s. Fashion and basic Ts, fashion skirts and cardigans continued to perform well in women’s and denim, T-shirts and colored woven tops were strong in men’s.

At Banana Republic, traffic was down 7% compared to a 4% decrease in April. Comp performance was better in women’s than men’s. In women’s, knits, dresses and wovens performed well and in men’s, long-sleeve knits, sweaters and outerwear performed well.

At Old Navy, performance was especially challenging, particularly in women’s. As we have said, we believe an important part of the issue is that we have put too much emphasis on fashion in our women’s assortment and we need to better balance the fashion product with the seasonal basic and basic product that customers expect from us. We are working to rebalance, but do not anticipate a material impact on the assortment until late fall.

Traffic was down 12% for the month compared to a 3% decline last month. By department, kids and baby performed better than adults, and men’s performed better than women’s. In women’s, sweaters, denim and dresses performed better and in men’s, short-sleeved knits and denim were key drivers of the business.

At international, comp results in Japan were better than Europe.

In terms of new product flows, Gap brands will receive a small women’s summer flow the week of June 8th, Banana Republic will receive a third women’s summer flow the week of June 8th, one week earlier than last year; Old Navy’s June flow will be fully set in stores the week of June 8th.

As a reminder, June sales will be announced on Thursday, July 10th prior to market opening. Thank you.

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