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 May 3, 1997 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) 427-2000 _______________________ 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, 269,476,100 shares as of June 13, 1997 <TABLE> PART 1 THE GAP, INC. AND SUBSIDIARIES ITEM 1 CONSOLIDATED BALANCE SHEETS ($000) May 3, February 1, May 4, 1997 1997 1996 (Unaudited) (See Note 1) (Unaudited) ASSETS <S> <C> <C> <C> Current Assets: Cash and equivalents $ 244,643 $ 485,644 $ 552,729 Short-term investments 112,268 135,632 79,819 Merchandise inventory 628,693 578,765 489,719 Prepaid expenses and other 151,132 129,214 146,791 Total Current Assets 1,136,736 1,329,255 1,269,058 Property and equipment (net) 1,174,003 1,135,720 981,011 Long-term investments 64,623 36,138 41,573 Lease rights and other assets 127,053 125,814 81,672 Total Assets $ 2,502,415 $ 2,626,927 $ 2,373,314 LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Notes payable 86,241 40,050 46,836 Accounts payable 296,089 351,754 204,951 Accrued expenses 213,698 282,494 214,131 Income taxes payable 58,927 91,806 13,901 Deferred lease credits and other current liabilities 8,845 8,792 7,034 Total Current Liabilities 663,800 774,896 486,853 Long-term Liabilities: Deferred lease credits and other liabilities 219,973 197,561 156,864 219,973 197,561 156,864 Stockholders' Equity: Common stock $.05 par value (a) Authorized 500,000,000 shares Issued 318,553,841, 317,864,090 and 316,892,180 shares Outstanding 271,390,413, 274,517,331 and 287,248,358 shares 15,928 15,895 15,845 Additional paid-in capital (a) 460,322 442,049 399,619 Retained earnings 2,002,458 1,938,352 1,629,666 Foreign currency translation adjustment (7,316) (5,187) (9,830) Restricted stock plan deferred compensation (42,897) (47,838) (43,757) Treasury stock, at cost (809,853) (688,801) (261,946) 1,618,642 1,654,470 1,729,597 Total Liabilities and Stockholders' Equity $ 2,502,415 $ 2,626,927 $ 2,373,314 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> THE GAP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS Unaudited ($000 except per share amounts) Thirteen Weeks Ended May 3, 1997 May 4, 1996 Net Sales $ 1,231,186 $ 1,113,154 Costs and expenses Cost of goods sold and occupancy expenses 789,126 699,314 Operating expenses 311,911 282,627 Net interest income (4,738) (3,618) Earnings before income taxes 134,887 134,831 Income taxes 50,583 53,258 Net earnings $ 84,304 $ 81,573 Weighted average number of shares (a) 273,469,190 288,010,684 Earnings per share (a) $.31 $.28 Cash dividends per share (a) $.075 $.075 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> THE GAP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Unaudited ($000) Thirteen Weeks Ended <S> <C> <C> May 3, 1997 May 4, 1996 Cash Flows from Operating Activities: Net earnings $ 84,304 $ 81,573 Adjustments to reconcile net earnings to net cash provided by (used for) operating activities: Depreciation and amortization (a) 56,659 52,616 Tax benefit from exercise of stock options by employees and from vesting of restricted stock 7,095 41,276 Change in operating assets and liabilities: Merchandise inventory (51,018) (7,212) Prepaid expenses and other (24,970) (18,750) Accounts payable (53,912) (57,289) Accrued expenses (68,504) 19,787 Income taxes payable (32,800) (52,201) Deferred lease credits and other long-term liabilities 25,218 6,117 Net cash provided by (used for) operating activities (57,928) 65,917 Cash Flows from Investing Activities: Net maturity of short-term investments 43,747 9,687 Purchase of long-term investments (48,868) (11,203) Purchase of property and equipment (93,787) (69,186) Acquisition of lease rights and other assets (378) (7,799) Net cash used for investing activities (99,286) (78,501) Cash Flows from Financing Activities: Net increase in notes payable 46,874 24,897 Issuance of common stock 10,870 22,121 Purchase of treasury stock (121,052) (39,886) Cash dividends paid (20,198) (21,254) Net cash used for financing activities (83,506) (14,122) Effect of exchange rate changes on cash (281) (131) Net decrease in cash and equivalents (241,001) (26,837) Cash and equivalents at beginning of year 485,644 579,566 Cash and equivalents at end of quarter $ 244,643 $ 552,729 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 May 3, 1997 and May 4, 1996, and the interim consolidated statements of earnings and the interim consolidated statements of cash flows for the thirteen weeks ended May 3, 1997 and May 4, 1996 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 May 3, 1997 and May 4, 1996, 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 1, 1997. The results of operations for the thirteen weeks ended May 3, 1997 are not necessarily indicative of the operating results that may be expected for the year ending January 31, 1998. 2. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Year-to-date 1997 and 1996 gross interest payments were $1.5 million and $0.8 million respectively; income tax payments were $77.4 million and $64.1 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 & 1111 Broadway, Suite 2100 Telephone (510)287-2700 Touche LLP 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 May 3, 1997 and May 4, 1996 and the related consolidated statements of earnings and cash flows for the thirteen week periods ended May 3, 1997 and May 4, 1996. 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 previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheet of The Gap, Inc. and subsidiaries as of February 1, 1997, 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 27, 1997, 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 1, 1997 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it was derived. /s/ Deloitte & Touche LLP May 14, 1997 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 May 3, May 4, 1997 1996 Net sales ($000) $1,231,186 $1,113,15 4 Total net sales growth 11 31 percentage Comparable store sales (3) 9 growth percentage Net sales per average 95 98 square foot Square footage of gross 13,163 11,436 store space (000) Fifty-two Fifty- weeks three ended weeks May 3, ended 1997 May 4, 1996 Number of New stores 230 225 Expanded stores 49 50 Closed stores 33 44 The increase in first quarter of 1997 net sales over the same period last year was attributable to the opening of new stores (net of stores closed) and the expansion of existing stores. The decrease in net sales per average square foot compared with the same period last year was primarily attributable to a decrease in comparable store sales. The growing impact of the Old Navy division also contributed to the decrease in net sales per square foot, as the division's lower-priced merchandise and significantly larger stores result in lower net sales per average square foot when compared to other divisions. Cost of Goods Sold and Occupancy Expenses Cost of goods sold and occupancy expenses as a percentage of net sales increased to 64.1 percent for the first quarter of 1997 from 62.8 percent for the same period in 1996. The resulting 1.3 percentage point decrease in gross margin net of occupancy expenses was attributable to a 1.1 percentage point decrease in merchandise margin as a percentage of net sales and a .2 percentage point increase in occupancy expenses as a percentage of net sales. The decrease in merchandise margin as a percentage of net sales was primarily attributable to a greater percentage of merchandise sold at markdown when compared to the same period last year. Margin achieved on marked-down goods was also lower than that of last year. The increase in occupancy expense 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 as a percentage of net sales were basically flat at 25.3 percent for the first quarter of 1997 and the same period in 1996. A planned increase in advertising/marketing costs to support the Company's brands offset a decrease in incentive bonus expense as a percentage of net sales. The Company accrued for larger bonuses in the first quarter of 1996 due to stronger earnings performance measured against the annual target. Net Interest Income/Expense Net interest income was approximately $4.7 million for the first quarter of 1997 compared to $3.6 million for the same period last year. Income Taxes The effective tax rate was 37.5 and 39.5 percent for the thirteen weeks ended May 3, 1997 and May 4, 1996, respectively. The decrease in the effective tax rate was a result of the impact from tax planning initiatives. LIQUIDITY AND CAPITAL RESOURCES The following sets forth certain measures of the Company's liquidity: Thirteen weeks ended May 3, May 4, 1997 1996 Cash provided by (used for) operating ($57,928) $ 65,917 activities ($000) Working capital ($000) $472,936 $ 782,205 Current ratio 1.71:1 2.61:1 For the thirteen weeks ended May 3, 1997, the decrease in cash flows from operating activities was attributable to an increased investment in merchandise inventory, increased activity under the Company's share repurchase program, and the timing of income tax payments. 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 an agreement which provides for a $250 million revolving credit facility through June 30, 2001. In addition, the credit agreement provides for the issuance of letters of credit up to $450 million at any one time. The Company has additional uncommitted credit of $260 million available for the issuance of letters of credit. The Company had outstanding letters of credit of approximately $536 million at May 3, 1997. For the thirteen weeks ended May 3, 1997, capital expenditures, net of construction allowances and dispositions, totaled approximately $88 million. These expenditures included the addition of 69 new stores, the expansion of 17 stores and the remodeling of certain stores resulting in a net increase in store space of approximately 518,000 square feet or 4 percent since February 1, 1997. For fiscal 1997, the Company expects capital expenditures to total approximately $450 million, net of construction allowances, representing the addition of at least 275 new stores, the expansion of approximately 65 to 75 stores, and the remodeling of certain stores. Planned expenditures also include amounts for administrative office 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 18 percent before store closings. New stores are generally expected to be leased. Included in the capital expenditures projection for fiscal 1997 is the cost to complete an office building at the Company's San Bruno campus. The Company also continues to explore alternatives for office facilities growth in San Francisco, California. 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 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. During the first quarter, the Company acquired 3.8 million shares for approximately $121 million. To date under this program, 8.5 million shares have been repurchased for approximately $261 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 May 3, 1997. 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: June 13, 1997 By /s/ Warren R. Hashagen Warren R. Hashagen Chief Financial Officer (Principal financial officer of the registrant) Date: June 13, 1997 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