SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [ X ] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended October 28, 1995 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ______________ to ______________ Commission File Number 1-7562 THE GAP, INC. (Exact name of registrant as specified in its charter) Delaware 94-1697231 (State of Incorporation) (I.R.S. Employer Identification No.) One Harrison San Francisco, California 94105 (Address of principal executive offices) Registrant's telephone number, including area code: (415)952-4400 _______________________ Securities registered pursuant to Section 12(b) of the Act: Common Stock, $0.05 par value New York Stock Exchange, Inc. (Title of class) Pacific Stock Exchange, Inc. (Name of each exchange where registered) Securities registered pursuant to Section 12(g) of the Act: None _______________________ Indicate by check mark whether Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate the number of shares outstanding of each of the issuer's classes of Common Stock, as of the latest practicable date. Common Stock, $0.05 par value, 143,859,338 shares as of December 8, 1995 <TABLE> PART 1 THE GAP, INC. AND SUBSIDIARIES ITEM 1 CONSOLIDATED BALANCE SHEETS <CAPTION> ($000) October 28, January 28, October 29, 1995 1995 1994 (Unaudited) (See Note 1) (Unaudited) ASSETS <S> <C> <C> <C> Current Assets: Cash and equivalents $ 324,182 $ 414,487 $ 223,654 Short-term investments 116,357 173,543 159,077 Merchandise inventory 704,847 370,638 537,343 Prepaid expenses and other 106,724 97,019 90,626 Total Current Assets 1,252,110 1,055,687 1,010,700 Property and equipment (net) 926,165 828,777 801,554 Long- term investments 7,059 32,097 62,418 Lease rights and other assets 101,436 87,683 73,632 Total Assets $ 2,286,770 $ 2,004,244 $ 1,948,304 LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Notes payable $ 17,781 $ 2,478 $ 2,936 Accounts payable 358,394 263,724 304,703 Accrued expenses 213,942 185,375 169,552 Income taxes payable 55,934 41,156 28,043 Deferred lease credits and other current liabilities 6,784 7,127 6,681 Total Current Liabilities 652,835 499,860 511,915 Long-term Liabilities: Deferred lease credits and other liabilities 146,260 129,152 119,719 146,260 129,152 119,719 Stockholders' Equity: Common stock $.05 par value Authorized 500,000,000 shares Issued 157,790,787, 156,972,777 and 156,661,757 shares Outstanding 143,486,359, 144,764,749 and 145,927,229 shares 7,891 7,849 7,834 Additional paid-in capital 332,553 298,413 285,096 Retained earnings 1,431,433 1,282,301 1,180,442 Foreign currency translation adjustment (6,347) (8,320) (4,521) Restricted stock plan deferred compensation (54,392) (54,265) (49,695) Treasury stock, at cost (223,463) (150,746) (102,486) 1,487,675 1,375,232 1,316,670 Total Liabilities and Stockholders' Equity $ 2,286,770 $ 2,004,244 $ 1,948,304 See accompanying notes to consolidated financial statements. </TABLE> <TABLE> THE GAP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS <CAPTION> Thirteen Weeks Ended Thirty-nine Weeks Ended Unaudited October 28, October 29, October 28, October 29, ($000 except per share amounts) 1995 1994 1995 1994 <S> <C> <C> <C> <C> Net sales $ 1,155,929 $ 988,346 $ 2,873,131 $ 2,513,147 Costs and expenses Cost of goods sold and 697,879 609,498 1,875,331 1,579,705 occupancy expenses Operating expenses 266,939 227,728 679,557 605,777 Net interest income (2,066) (3,669) (11,345) (5,355) Earnings before income taxes 193,177 154,789 329,588 333,020 Income taxes 76,302 61,142 130,186 131,543 Net earnings $ 116,875 $ 93,647 $ 199,402 $ 201,477 Weighted average number of shares 144,210,859 145,850,581 144,066,284 145,650,754 Earnings per share $ .81 $ .64 $ 1.38 $ 1.38 Cash dividends per share $ .12 $ .12 $ .36 $ .34 See accompanying notes to consolidated financial statements. </TABLE> <TABLE> THE GAP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS <CAPTION> Unaudited ($000) Thirty-Nine Weeks Ended October 28, 1995 October 29, 1994 <S> <C> <C> Cash Flows from Operating Activities: Net earnings $199,402 $201,477 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 147,114 123,574 Tax benefit from exercise of stock options by employees and from vesting of restricted stock 9,325 15,562 Deferred income taxes - (7,331) Change in operating assets and liabilities: Merchandise inventory (334,197) (205,157) Prepaid expenses and other (19,567) (6,712) Accounts payable 95,925 87,236 Accrued expenses 28,526 5,870 Income taxes payable 14,647 (42,137) Deferred lease credits and other long-term liabilities 16,541 22,782 Net cash provided by operating activities 157,716 195,164 Cash Flows from Investing Activities: Maturity (purchase) of short-term investments - net 82,224 (52,329) Purchase of long-term investments - (85,669) Purchases of property and equipment (223,024) (164,170) Acquisition of lease rights and other assets (7,378) (4,560) Net cash used for investing activities (148,178) (306,728) Cash Flows from Financing Activities: Net (decrease) increase in notes payable 15,303 (5,765) Payment on long-term debt - (75,000) Issuance of common stock 7,297 12,770 Purchase of treasury stock (72,717) (10,032) Cash dividends paid (50,270) (47,870) Net cash used for financing activities (100,387) (125,897) Effect of exchange rate changes on cash 544 783 Net (decrease) increase in cash and equivalents (90,305) (236,678) Cash and equivalents at beginning of year 414,487 460,332 Cash and equivalents at end of quarter $324,182 $223,654 See accompanying notes to consolidated financial statements. </TABLE> THE GAP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. BASIS OF PRESENTATION The consolidated balance sheets as of October 28, 1995 and October 29, 1994, and the interim consolidated statements of earnings for the thirteen and thirty-nine weeks ended October 28, 1995 and October 29, 1994 and the interim consolidated statements of cash flows for the thirty-nine weeks ended October 28, 1995 and October 29, 1994 have been prepared by the Company, without audit. In the opinion of management, all adjustments (which include only normal recurring adjustments) considered necessary to present fairly the financial position, results of operations and cash flows of the Company at October 28, 1995 and October 29, 1994, and for all periods presented, have been made. Certain information and footnote disclosures normally included in the annual financial statements prepared in accordance with generally accepted accounting principles have been omitted from these interim financial statements. It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company's annual report on Form 10-K for the year ended January 28, 1995. The results of operations for the thirty-nine weeks ended October 28, 1995 are not necessarily indicative of the operating results that may be expected for the year ending February 3, 1996. Certain reclassifications have been made to the 1994 financial statements to conform to classifications used in 1995. 2. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Year-to-date 1995 and 1994 gross interest payments were $3.4 million and $7.4 million respectively; income tax payments were $105.5 million and $155.1 million respectively. Deloitte & Touche LLP 2101 Webster Street Telephone:(510)287-2700 Oakland, California 94612 Facsimile:(510)835-4888 INDEPENDENT ACCOUNTANTS' REPORT To the Board of Directors and Stockholders of The Gap, Inc.: We have reviewed that accompanying consolidated balance sheets of The Gap, Inc. and subsidiaries as of October 28, 1995 and October 29, 1994 and the related consolidated statements of earnings for the thirteen week and thirty- nine week periods ended October 28, 1995 and October 29, 1994 and of cash flows for the thirty-nine week periods ending October 28, 1995 and October 29, 1994. These financial statements are the responsibility of the Company's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and of making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our reviews, we are not aware of any material modifications that should be made to such interim consolidated financial statements for them to be in conformity with generally accepted accounting principles. We have previous audited, in accordance with generally accepted auditing standards, the consolidated balance sheet of The Gap, Inc. and subsidiaries as of January 28, 1995, and the related consolidated statements of earnings, stockholders' equity and cash flows for the year then ended (not presented herein); and in our report dated March 2, 1995, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of January 28, 1995 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it was derived. November 8, 1995 Deloitte Touche Tohmatsu International Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION RESULTS OF OPERATIONS Net Sales Thirteen Weeks Ended Thirty-nine Weeks Ended October 28, October 29, October 28, October 29, 1995 1994 1995 1994 Net sales ($000) 1,155,929 988,346 2,873,131 2,513,147 Total net sales growth percentage 17 10 14 12 Comparable store sales growth percentage 0 <2> <2> 2 Net sales per average square foot 111 115 290 310 Fifty-two Weeks Ended October 28, October 29, 1995 1994 Number of: New stores 209 143 Expanded stores 61 93 Closed stores 43 51 The increases in third quarter and year-to-date 1995 net sales over the same periods last year were primarily attributable to the opening of new stores (net of stores closed) and the expansion of existing stores. The declines in third quarter and year-to-date net sales per average square foot from the same periods last year were attributable to increases in the average size of new stores in connection with the Company's store expansion program and continued store growth in the Old Navy division with lower priced merchandise and significantly larger stores. For the four week period ended November 25, 1995, net sales increased 19 percent over the same period last year. Comparable store sales increased 1 percent in both November 1995 and November 1994. However, comparable store sales for the last week of November 1995 (the first week of the Christmas selling season) were disappointing. The retail sales environment continues to be challenging and results for the fourth quarter will be dependent upon Christmas holiday period sales. Cost of Goods Sold and Occupancy Expenses Cost of goods sold and occupancy expenses as a percentage of net sales decreased to 60.4 percent for the third quarter of 1995 from 61.7 percent for the same period in 1994. The resulting 1.3 percentage point increase in gross margin net of occupancy expenses was attributable to higher merchandise margins due to increased regular priced selling. Cost of goods sold and occupancy expenses as a percentage of net sales increased to 65.3 percent for the year-to-date period from 62.9 percent for the same period in 1994. The resulting 2.4 percentage point decrease in gross margin net of occupancy expenses was attributable to a 2.1 percentage point decrease in merchandise margin as a percentage of net sales and a .3 percentage point increase in occupancy expenses as a percentage of net sales. The decrease in merchandise margin as a percentage of net sales was driven by a decline in initial merchandise margin, primarily in the first half. The increase in occupancy expenses as a percentage of net sales was primarily attributable to a lack of sales leverage resulting from negative comparable store sales. The Company reviews its inventory levels in order to identify slow-moving merchandise and broken assortments (items no longer in stock in a sufficient range of sizes) and uses markdowns to clear merchandise. Such markdowns may have an adverse impact on earnings, depending upon the extent of the markdowns and amount of inventory affected. Operating Expenses Operating expenses were essentially flat as a percentage of net sales at 23.1 percent for the third quarter of 1995 compared to 23.0 percent for the same period last year. Operating expenses decreased as a percentage of net sales to 23.6 percent year-to-date compared to 24.1 percent for the same period last year. The .5 percentage point decrease was primarily attributable to a decrease in incentive bonus expense as a percentage of net sales. Due to the Company's performance relative to financial targets, less bonus expense was recognized this year. Net Interest Income Net interest income was approximately $2.1 million for the third quarter compared to net interest income of $3.7 million for the same period last year. The decrease was primarily attributable to additional interest expense recognized for various other obligations, partially offset by an increase in income from higher average interest rates. For the thirty-nine weeks ended October 28, 1995, net interest income was approximately $11.3 million compared to net interest income of $5.4 million last year. The change was attributable to an increase in income from higher average interest rates and reductions in interest expense resulting from the June 1994 repayment of long-term debt. Income Taxes The effective income tax rate was 39.5 percent for the first nine months of both 1995 and 1994. The Company does not anticipate any changes in the effective tax rate for the remainder of 1995. LIQUIDITY AND CAPITAL RESOURCES The following sets forth certain measures of the Company's liquidity: Thirty-nine weeks ended October 28, 1995 October 29, 1994 Cash provided by operating activities ($000) $157,716 $195,164 Working capital ($000) $599,275 $498,785 Current ratio 1.92:1 1.97:1 For the thirty-nine weeks ended October 28, 1995, the decrease in cash flows from operating activities was attributable to an increased investment in inventory partially offset by a decrease in income tax payments. The Company's overall cash and liquidity position continues to be strong. The Company funds inventory expenditures during normal and peak periods through a combination of cash flows provided by operating activities and normal trade credit arrangements. The Company's business follows a seasonal pattern, peaking over a period of about ten weeks during the late summer and holiday months. For the thirty-nine weeks ended October 28, 1995, capital expenditures, net of construction allowances and dispositions, totalled approximately $214 million. These expenditures included the addition of 162 new stores, the expansion of 44 stores and the remodeling of certain stores resulting in a net increase in store space of approximately 1.5 million square feet or 16 percent since January 28, 1995. For fiscal year 1995, the Company expects capital expenditures to total approximately $300 million, net of construction allowances, representing the addition of approximately 200 to 225 new stores, the expansion of approximately 50 to 70 stores, and the remodeling of certain stores. Square footage growth is expected to be approximately 20 percent after accounting for store closings. New stores are generally expected to be leased. The Company expects to fund such capital expenditures with cash flow from operations. For fiscal year 1996, the Company currently expects capital expenditures to total approximately $300 to $350 million, net of construction allowances. These expenditures include the addition of approximately 200 new stores, and the expansion of approximately 55 stores. Square footage growth is expected to be approximately 15 to 20 percent after accounting for store closings. The amounts above include planned expenditures for administrative facilities, distribution centers and equipment. The Company continues to explore alternatives for additional office space in San Francisco and San Bruno, California. The Company has commenced construction of a distribution center in Gallatin, Tennessee for an estimated cost at completion of $45 to $55 million. The facility is expected to be in operation in late 1996. The Company has a credit agreement which provides for a $250 million revolving credit facility until March 1998. In addition, the credit agreement provides for the issuance of letters of credit up to $500 million at any one time. The Company had outstanding letters of credit of approximately $417 million at October 28, 1995. During the third quarter of 1995, the Company acquired 828,100 shares of its common stock for $30,739,000. The shares were purchased under a program announced in October 1994 to repurchase up to 9 million shares of the Company's outstanding common stock. To date under this program, 3,569,900 shares have been repurchased for $120,977,000. PART II OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K a) Exhibits (10) Credit Agreement, dated as of August 1, 1995, among Registrant and Citicorp USA Inc.; Bank of America National Trust & Savings Texas, N.A.; The Royal Bank of Canada; Bank of Montreal; Societe Generale; The Fuji Bank, Limited; U.S. National Bank of Oregon; Morgan Guaranty Trust Company of New York; The Sumitomo Bank Limited; and Citibank, N.A. (11) Computation of Earnings per Share (15) Letter re: Unaudited Interim Financial Information (27) Financial Data Schedule b) The Company did not file any reports on Form 8-K during the three months ended October 28, 1995. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. THE GAP, INC. Date: December 8, 1995 By /s/ Warren R. Hashagen Warren R. Hashagen Chief Financial Officer (Principal financial officer of the registrant) Date: December 8, 1995 By /s/ Millard S. Drexler Millard S. Drexler President and Chief Executive Officer EXHIBIT INDEX (10) Credit Agreement, dated as of August 1, 1995, among Registrant and Citicorp USA Inc.; Bank of America National Trust & Savings Association; National Westminster Bank PLC; Nationsbank of Texas, N.A.; The Royal Bank of Canada; Bank of Montreal; Societe Generale; The Fuji Bank, Limited; U.S. National Bank of Oregon; Morgan Guaranty Trust Company of New York; The Sumitomo Bank Limited; and Citibank, N.A. (11) Computation of Earnings per Share (15) Letter re: Unaudited Interim Financial Information (27) Financial Data Schedule