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 November 2, 1996 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 ofIncorporation) (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, 279,247,842 shares as of December 13, 1996 PART 1 THE GAP, INC. AND SUBSIDIARIES ITEM 1 CONSOLIDATED BALANCE SHEETS <TABLE> <CAPTION> ($000) November 2, February 3, October 28, 1996 1996 1995 (Unaudited) (See Note 1) (Unaudited) ASSETS <S> <C> <C> <C> Current Assets: Cash and equivalents $ 477,272 $ 579,566 $ 324,182 Short-term investments 109,340 89,506 116,357 Merchandise inventory 711,934 482,575 704,847 Prepaid expenses and other 140,033 128,398 106,724 Total Current Assets 1,438,579 1,280,045 1,252,110 Property and equipment (net) 1,067,607 957,752 926,165 Long-term investments 37,966 30,370 7,059 Lease rights and other assets 84,004 74,901 101,436 Total Assets $ 2,628,156 $ 2,343,068 $ 2,286,770 LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Notes payable 86,333 21,815 17,781 Accounts payable 390,206 262,505 358,394 Accrued expenses 271,418 194,426 213,942 Income taxes payable 61,432 66,094 55,934 Deferred lease credits and other current liabilities 9,829 6,904 6,784 Total Current Liabilities 819,218 551,744 652,835 Long-term Liabilities: Deferred lease credits and other liabilities 176,712 150,851 146,260 176,712 150,851 146,260 Stockholders' Equity: Common stock $.05 par value (a) Authorized 500,000,000 shares Issued 317,515,944, 315,971,306 and 315,581,574 shares Outstanding 278,743,066, 287,747,984 and 286,972,718 shares 15,877 15,799 15,779 Additional paid-in capital (a) 420,271 335,193 324,665 Retained earnings 1,787,708 1,569,347 1,431,433 Foreign currency translation adjustment (3,036) (9,071) (6,347) Restricted stock plan deferred compensation (42,132) (48,735) (54,392) Treasury stock, at cost (546,462) (222,060) (223,463) 1,632,226 1,640,473 1,487,675 Total Liabilities and Stockholders' Equity $ 2,628,156 $ 2,343,068 $ 2,286,770 See accompanying notes to consolidated financial statements. (a) Reflects the two-for-one split of common stock in the form of a stock dividend to stockholders of record on March 18, 1996. </TABLE> <TABLE> <CAPTION> THE GAP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS Thirteen Weeks Ended Thirty-nine Weeks Ended <S> <C> <C> <C> <C> Unaudited November 2, October 28, November 2, October 28, ($000 except per share amounts 1996 1995 1996 1995 Net sales $ 1,382,996 $ 1,155,929 $ 3,616,485 $ 2,873,131 Costs and expenses Cost of goods sold and 837,775 697,879 2,257,254 1,875,331 occupancy expenses Operating expenses 328,434 266,939 906,442 679,557 Net interest income (5,213) (2,066) (12,787) (11,345) Earnings before income taxes 222,000 193,177 465,576 329,588 Income taxes 87,690 76,302 183,903 130,186 Net earnings $ 134,310 $ 116,875 $ 281,673 $ 199,402 Weighted average number of shares (a) 281,746,335 288,421,718 285,302,456 288,132,568 Earnings per share (a) $ 0.48 $ 0.41 $ 0.99 $ 0.69 Cash dividends per share (a) $ 0.075 $ 0.06 $ 0.225 $ 0.18 See accompanying notes to consolidated financial statements. (a) Reflects the two-for-one split of common stock in the form of a stock dividend to stockholders of record on March 18, 1996. </TABLE> <TABLE> <CAPTION> THE GAP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Unaudited ($000) Thirty-nine Weeks Ended November 2, 1996 October 28, 1995 <S> <C> <C> Cash Flows from Operating Activities: Net earnings $281,673 $199,402 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization (a) 156,699 147,114 Tax benefit from exercise of stock options by employees and from vesting of restricted stock 45,559 9,325 Change in operating assets and liabilities: Merchandise inventory (226,535) (334,197) Prepaid expenses and other (13,274) (19,567) Accounts payable 124,472 95,925 Accrued expenses 76,493 28,526 Income taxes payable (4,893) 14,647 Deferred lease credits and other long-term liabilities 33,973 16,541 Net cash provided by operating activities 474,167 157,716 Cash Flows from Investing Activities: Net maturity of short-term investments 4,181 82,224 Purchase of long-term investments (31,611) - Purchases of property and equipment (246,831) (223,024) Acquisition of lease rights and other assets (9,880) (7,378) Net cash used for investing activities (284,141) (148,178) Cash Flows from Financing Activities: Net increase (decrease) in notes payable 63,291 15,303 Issuance of common stock 28,853 7,297 Purchase of treasury stock (324,402) (72,717) Cash dividends paid (63,312) (50,270) Net cash used for financing activities (295,570) (100,387) Effect of exchange rate changes on cash 3,250 544 Net decrease in cash and equivalents (102,294) (90,305) Cash and equivalents at beginning of year 579,566 414,487 Cash and equivalents at end of quarter $477,272 $324,182 See accompanying notes to consolidated financial statements. (a) Includes amortization of restricted stock. </TABLE> THE GAP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. BASIS OF PRESENTATION The consolidated balance sheets as of November 2, 1996 and October 28, 1995, and the interim consolidated statements of earnings and the interim consolidated statements of cash flows for the thirteen and thirty-nine weeks ended November 2, 1996 and October 28, 1995 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 November 2, 1996 and October 28, 1995, 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 February 3, 1996. The results of operations for the thirty-nine weeks ended November 2, 1996 are not necessarily indicative of the operating results that may be expected for the year ending February 1, 1997. 2. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Year-to-date 1996 and 1995 gross interest payments were $4.0 million and $3.4 million respectively; income tax payments were $142.7 million and $105.5 million respectively. 3. TWO-FOR-ONE STOCK SPLIT On February 27, 1996, the Company's Board of Directors authorized a two-for-one split of its common stock effective April 10, 1996, in the form of a stock dividend for stockholders of record on March 18, 1996. Per share amounts in the accompanying consolidated financial statements give effect to the stock split. Deloitte & Touche LLP 1111 Broadway #2100 Telephone:(510) 287-2700 Oakland, California 94607-4036 Facsimile:(510) 835-4888 INDEPENDENT ACCOUNTANTS' REPORT To the Board of Directors and Stockholders of The Gap, Inc.: We have reviewed the accompanying consolidated balance sheets of The Gap, Inc. and subsidiaries as of November 2, 1996 and October 28, 1995 and the related consolidated statements of earnings for the thirteen and thirty-nine week periods ended November 2, 1996 and October 28, 1995 and consolidated statements of cash flows for the thirty-nine week periods ending November 2, 1996 and October 28, 1995. These financial statements are the responsibility of the Company's management. We conducted our reviews 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 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 February 3, 1996, 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 February 29, 1996 (except for the effects of the stock split and the 1996 stock option and award plan, as to which the date is April 10, 1996), 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 February 3, 1996 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it was derived. /s/ Deloitte & Touche LLP November 13, 1996 Deloitte Touche Tohmatsu International THE GAP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION RESULTS OF OPERATIONS Net Sales Thirteen Weeks Ended Thirty-nine Weeks Ended November October November October 2, 1996 28, 1995 2, 1996 28, 1995 Net sales ($000) 1,382,996 1,155,929 3,616,485 2,873,131 Total net sales growth 20 17 26 14 percentage Comparable store sales 1 0 6 <2> growth percentage Net sales dollars per 114 111 308 290 average square foot Average square footage of 12,166 10,430 11,736 9,908 gross store space (000) Fifty- Fifty-two three weeks weeks ended ended October November 28, 1995 2, 1996 Number of New stores 220 209 Expanded stores 43 61 Closed stores 43 43 The increases in third quarter and year-to-date 1996 net sales over the same periods last year were primarily attributable to the opening of new stores (net of stores closed) and an increase in comparable stores sales. The increases in third quarter and year-to-date net sales per average square foot from the same periods last year were primarily attributable to increases in comparable stores sales aided by the smaller size of new stores. Cost of Goods Sold and Occupancy Expenses For the third quarter of 1996, cost of goods sold and occupancy expenses as a percentage of net sales increased to 60.6 from 60.4 percent for the same period in 1995. The .2 percentage point decrease in gross margin net of occupancy expense was attributable to a 1.0 percentage point decrease in merchandise margins offset by a .8 percentage point decrease in occupancy expenses as a percentage of net sales. The increases in initial merchandise margins were more than offset by declines in the percentage of merchandise sold at regular price and in the margins achieved on marked down goods when compared to the same period last year. The decrease in occupancy expenses as a percentage of net sales resulted from the growth of the Old Navy division which carries lower occupancy expenses as a percentage of net sales when compared to other divisions. For the year-to-date period of 1996, cost of goods sold and occupancy expenses as a percentage of net sales decreased to 62.4 from 65.3 for the same period in 1995. The 2.9 percentage point increase in gross margin net of occupancy expense was attributable to a 1.5 percentage point increase in merchandise margins and a 1.4 percentage point decrease in occupancy expenses as a percentage of net sales. The increases in merchandise margins as a percentage of net sales was driven by higher initial merchandise margins and a larger percentage of merchandise sold at regular prices when compared to the same period last year. Margins achieved on marked down goods were also higher than last year. The decrease in occupancy expenses as a percentage of net sales was primarily attributable to the effect of the growth of the Old Navy division and leverage achieved through comparable store sales growth. 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 as a percentage of net sales increased to 23.7 percent for the third quarter of 1996 from 23.1 percent for the same period in 1995. The .6 percentage point increase was primarily due to a .4 percentage point increase in advertising/marketing costs to support the Company's brands and a .2 percentage point increase in incentive bonus expense. For the year-to-date period, operating expenses as a percentage of net sales increased to 25.1 percent from 23.6 percent for the same period in 1995. The 1.5 percentage point increase was primarily attributable to a .7 percentage point increase in incentive bonus expense and a .3 percentage point increase in advertising to support the Company's brands. Net Interest Income Net interest income was $5.2 million and $12.8 million for the third quarter and year-to-date periods respectively compared to net interest income of $2.1 million and $11.3 million for the same periods in 1995. The change in 1996 from 1995 was primarily attributable to an increase in average investments for the quarter and year-to-date periods. Income Taxes The Company's effective tax rate was 39.5 percent for the first nine months of both 1996 and 1995. LIQUIDITY AND CAPITAL RESOURCES The following sets forth certain measures of the Company's liquidity: Thirty-nine weeks ended November 2, October 28, 1996 1995 Cash provided by operating $474,167 $157,716 activities ($000) Working capital ($000) $619,361 $599,275 Current ratio 1.76:1 1.92:1 For the thirty-nine weeks ended November 2, 1996, the increase in cash flows provided by operating activities was primarily attributable to an increase in net earnings exclusive of depreciation expense and a decreased investment in inventory resulting from improved inventory management and a planned shift in the receipt of holiday merchandise. The Company funds inventory expenditures during normal and peak periods through a combination of cash flows provided by operations and normal trade credit arrangements. The Company's business follows a seasonal pattern, peaking over a total of about ten to twelve weeks during the late summer and holiday periods. The company has a credit agreement which provides for $250 million revolving credit facility through June 30, 1998. In addition, the credit agreement provides, on a committed basis, for the issuance of letters of credit up to $450 million at any one time. Outstanding letters of credit, including committed and uncommitted lines of credit, totaled approximately $516 million at November 2, 1996. For the thirty-nine weeks ended November 2, 1996, capital expenditures totaled approximately $237 million, net of disposals. These expenditures included the addition of 157 new stores, the expansion of 32 stores and the remodeling of certain stores resulting in a net increase in store space of approximately 1.2 million square feet or 11% since February 3, 1996. For 1996, the Company expects capital expenditures to total approximately $350 million before dispositions, representing the addition of approximately 200 new stores, the expansion of approximately 40 to 50 stores, and the remodeling of certain stores. Planned expenditures also include amounts for administrative facilities, distribution centers, and equipment. The Company expects to fund such capital expenditures with cash flow from operations. Square footage growth is expected to be approximately 15 percent before store closings. New stores are generally expected to be leased. During 1996, the Company completed construction of a distribution center in Gallatin, Tennessee for approximately $55 million. The facility became fully operational in September 1996. Additionally in May 1996, the Company purchased land and a building in the Netherlands for approximately $10 million to relocate its European distribution center. The distribution center, which began operating in June 1996, provides a central shipping location to the European continent. In February 1996, the Company exercised an option to purchase land for $9 million in San Bruno, California to expand its headquarters facilities. Construction commenced in April 1996 for an estimated cost at completion of $55 to $60 million. The facility is expected to be in operation in late 1997. On February 27, 1996, the Company's Board of Directors authorized a two-for- one split of its common stock effective April 10, 1996, in the form of a stock dividend to stockholders of record at the close of business on March 18, 1996. Per share amounts in the accompanying consolidated financial statements give effect to the stock split. In October 1996, The Board of Directors approved a program under which the Company may repurchase up to 30 million shares of its outstanding common stock in the open market over a three-year period. No shares were purchased under this program during the third quarter of 1996. The program announced in October of 1996 follows an 18 million share repurchase program which was approved in October 1994 and completed in November 1996. Under this program, 10.8 million shares were acquired in 1996 for approximately $325 million. The cost for the entire 18 million shares program was approximately $450 million. PART II OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K a) Exhibits (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 November 2, 1996. 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 13, 1996 By /s/Warren R. Hashagen Warren R. Hashagen Chief Financial Officer (Principal financial officer of the registrant) Date: December 13, 1996 By /s/Millard S. Drexler Millard S. Drexler President and Chief Executive Officer EXHIBIT INDEX (11) Computation of Earnings per Share (15) Letter re: Unaudited Interim Financial Information (27) Financial Data Schedule