Gap Inc. Gap Banana Republic Old Navy
Ten-Year Selected Financial Data
Compound Annual Growth Rate Fiscal Year
----------------------------------- -------------------------
1998 1997
3-year 5-year 10-year 52 weeks 52 weeks
----------------------------------- -------------------------
OPERATING RESULTS ($000)
Net sales 27% 22% 22% $9,054,462 $6,507,825
Cost of goods sold and occupancy expenses,
excluding depreciation and amortization - - - 5,013,473 3,775,957
Percentage of net sales - - - 55.4% 58.0%
Depreciation and amortization/(a)/ - - - $ 304,745 $ 245,584
Operating expenses - - - 2,403,365 1,635,017
Net interest expense (income) - - - 13,617 (2,975)
Earnings before income taxes 31 25 26 1,319,262 854,242
Percentage of net sales - - - 14.6% 13.1%
Income taxes - - - $ 494,723 $ 320,341
Net earnings 33 26 27 824,539 533,901
Percentage of net sales - - - 9.1% 8.2%
Cash dividends paid - - - $ 76,888 $ 79,503
Capital expenditures - - - 842,655 483,114
-------------------------------------------------------------------------------------
PER SHARE DATA
Net earnings--basic 36% 28% 28% $1.43 $.90
Net earnings--diluted 36 28 29 1.37 .87
Cash dividends paid/(b)/ - - - .13 .13
Shareholders' equity (book value) - - - 2.75 2.69
-------------------------------------------------------------------------------------
FINANCIAL POSITION ($000)
Property and equipment, net 25% 20% 26% $1,876,370 $1,365,246
Merchandise inventory 30 26 19 1,056,444 733,174
Total assets 19 18 23 3,963,919 3,337,502
Working capital - - - 318,721 839,399
Current ratio - - - 1.21:1 1.85:1
Total long-term debt, less current
installments - - - $ 496,455 $ 496,044
Ratio of long-term debt to shareholders'
equity - - - .32:1 .31:1
Shareholders' equity - - - $1,573,679 $1,583,986
Return on average assets - - - 22.6% 17.9%
Return on average shareholders' equity - - - 52.2% 33.0%
-------------------------------------------------------------------------------------
STATISTICS
Number of stores opened 12% 24% 12% 318 298
Number of stores expanded - - - 135 98
Number of stores closed - - - 20 22
Number of stores open at year-end/(c)/ 13 12 10 2,428 2,130
Net increase in number of stores - - - 14% 15%
Comparable store sales growth (52-week basis) - - - 17% 6%
Sales per square foot (52-week basis)/(d)/ - - - $532 $463
Square footage of gross store space at year-end 19 20 17 18,757,400 15,312,700
Percentage increase in square feet - - - 22% 21%
Number of employees at year-end 23 20 19 111,000 81,000
Weighted-average number of shares--basic - - - 576,041,373 594,269,963
Weighted-average number of shares--diluted - - - 602,916,255 615,301,137
Number of shares outstanding at year-end,
net of treasury stock - - - 571,973,354 589,699,542
-------------------------------------------------------------------------------------
(a) Excludes amortization of restricted stock, discounted stock options and
discount on long-term debt.
(b) Excludes a dividend of $.0333 per share declared in January 1999 but paid
in the first quarter of fiscal 1999.
(c) Includes the conversion of GapKids departments to their own separate stores.
Converted stores are not classified as new stores.
(d) Based on weighted-average gross square footage.
page 22 1998 Annual Report
Gap Inc. Gap Banana Republic Old Navy
Ten-Year Selected Financial Data (continued)
Fiscal Year
- - ------------------------------------------------------------------------------------------------------------------------------------
1996 1995 1994 1993
52 weeks 53 weeks 52 weeks 52 weeks
-------------------------------------------------------------------------------
OPERATING RESULTS ($000)
Net sales $5,284,381 $4,395,253 $3,722,940 $3,295,679
Cost of goods sold and occupancy expenses,
excluding depreciation and amortization 3,093,709 2,645,736 2,202,133 1,996,929
Percentage of net sales 58.5% 60.2% 59.2% 60.6%
Depreciation and amortization/(a)/ $ 191,457 $ 175,719 $ 148,863 $ 124,860
Operating expenses 1,270,138 1,004,396 853,524 748,193
Net interest expense (income) (19,450) (15,797) (10,902) 809
Earnings before income taxes 748,527 585,199 529,322 424,888
Percentage of net sales 14.2% 13.3% 14.2% 12.9%
Income taxes $ 295,668 $ 231,160 $ 209,082 $ 166,464
Net earnings 452,859 354,039 320,240 258,424
Percentage of net sales 8.6% 8.1% 8.6% 7.8%
Cash dividends paid $ 83,854 $ 66,993 $ 64,775 $ 53,041
Capital expenditures 375,838 309,599 236,616 215,856
-------------------------------------------------------------------------------
PER SHARE DATA
Net earnings--basic $ .72 $ .57 $ .51 $ .41
Net earnings--diluted .71 .55 .49 .40
Cash dividends paid/(b)/ .13 .11 .10 .09
Shareholders' equity (book value) 2.68 2.53 2.11 1.72
-------------------------------------------------------------------------------
FINANCIAL POSITION ($000)
Property and equipment, net $1,135,720 $ 957,752 $ 828,777 $ 740,422
Merchandise inventory 578,765 482,575 370,638 331,155
Total assets 2,626,927 2,343,068 2,004,244 1,763,117
Working capital 554,359 728,301 555,827 494,194
Current ratio 1.72:1 2.32:1 2.11:1 2.07:1
Total long-term debt, less current installments -- -- -- 75,000
Ratio of long-term debt to shareholders' equity N/A N/A N/A .07:1
Shareholders' Equity $1,654,470 $1,640,473 $1,375,232 $1,126,475
Return on average assets 18.2% 16.3% 17.0% 16.4%
Return on average shareholders' equity 27.5% 23.5% 25.6% 25.7%
-------------------------------------------------------------------------------
STATISTICS
Number of stores opened 203 225 172 108
Number of stores expanded 42 55 82 130
Number of stores closed 30 53 34 45
Number of stores open at year-end/(c)/ 1,854 1,680 1,508 1,370
Net increase in number of stores 10% 11% 10% 5%
Comparable store sales growth (52-week basis) 5% 0% 1% 1%
Sales per square foot (52-week basis)/(d)/ $441 $425 $444 $463
Square footage of gross store space at year-end 12,645,000 11,100,200 9,165,900 7,546,300
Percentage increase in square feet 14% 21% 21% 16%
Number of employees at year-end 66,000 60,000 55,000 44,000
Weighted-average number of shares--basic 625,719,947 626,577,596 632,466,639 626,858,004
Weighted-average number of shares--diluted 640,900,830 641,628,773 647,429,741 643,406,853
Number of shares outstanding at year-end,
net of treasury stock 617,663,996 647,432,964 651,441,371 653,619,276
-------------------------------------------------------------------------------
Fiscal Year
----------------------------------------------------------------------------------
1992 1991 1990 1989
52 weeks 52 weeks 52 weeks 53 weeks
----------------------------------------------------------------------------------
OPERATING RESULTS ($000)
Net sales $2,960,409 $2,518,893 $1,933,780 $1,586,596
Cost of goods sold and occupancy expenses,
excluding depreciation and amortization 1,856,102 1,496,156 1,187,644 1,006,647
Percentage of net sales 62.7% 59.4% 61.4% 63.4%
Depreciation and amortization/(a)/ $ 99,451 $ 72,765 $ 53,599 $ 39,589
Operating expenses 661,252 575,686 454,180 364,101
Net interest expense (income) 3,763 3,523 1,435 2,760
Earnings before income taxes 339,841 370,763 236,922 162,714
Percentage of net sales 11.5% 14.7% 12.3% 10.3%
Income taxes $ 129,140 $ 140,890 $ 92,400 $ 65,086
Net earnings 210,701 229,873 144,522 97,628
Percentage of net sales 7.1% 9.1% 7.5% 6.2%
Cash dividends paid $ 44,106 $ 41,126 $ 29,625 $ 22,857
Capital expenditures 213,659 244,323 199,617 94,266
----------------------------------------------------------------------------------
PER SHARE DATA
Net earnings--basic $ .34 $ .38 $.24 $.16
Net earnings--diluted .33 .36 .23 .15
Cash dividends paid/(b)/ .07 .07 .05 .04
Shareholders' equity (book value) 1.37 1.06 .73 .53
----------------------------------------------------------------------------------
FINANCIAL POSITION ($000)
Property and equipment, net $ 650,368 $ 547,740 $383,548 $238,103
Merchandise inventory 365,692 313,899 247,462 243,482
Total assets 1,379,248 1,147,414 776,900 579,483
Working capital 355,649 235,537 101,518 129,139
Current ratio 2.06:1 1.71:1 1.39:1 1.69:1
Total long-term debt, less current installments $ 75,000 $ 80,000 $ 17,500 $ 20,000
Ratio of long-term debt to shareholders' equity .08:1 .12:1 .04:1 .06:1
Shareholders' equity $ 887,839 $ 677,788 $465,733 $337,972
Return on average assets 16.7% 23.9% 21.3% 18.4%
Return on average shareholders' equity 26.9% 40.2% 36.0% 31.8%
----------------------------------------------------------------------------------
STATISTICS
Number of stores opened 117 139 152 98
Number of stores expanded 94 79 56 7
Number of stores closed 26 15 20 38
Number of stores open at year-end/(c)/ 1,307 1,216 1,092 960
Net increase in number of stores 7% 11% 14% 7%
Comparable store sales growth (52-week basis) 5% 13% 14% 15%
Sales per square foot (52-week basis)/(d)/ $489 $481 $438 $389
Square footage of gross store space at year-end 6,509,200 5,638,400 4,762,300 4,056,600
Percentage increase in square feet 15% 18% 17% 5%
Number of employees at year-end 39,000 32,000 26,000 23,000
Weighted-average number of shares--basic 618,944,994 610,511,282 602,947,623 599,771,631
Weighted-average number of shares--diluted 640,602,521 635,531,438 629,967,009 630,929,312
Number of shares outstanding at year-end,
net of treasury stock 648,833,571 641,355,003 635,688,135 632,481,318
----------------------------------------------------------------------------------
(a) Excludes amortization of restricted stock, discounted stock options and
discount on long-term debt.
(b) Excludes a dividend of $.0333 per share declared in January 1999 but paid
in the first quarter of fiscal 1999.
(c) Includes the conversion of GapKids departments to their own separate stores.
Converted stores are not classified as new stores.
(d) Based on weighted-average gross square footage.
1998 Annual Report page 23
Management's Discussion and Analysis
of Results of Operations and Financial Condition
The information below and elsewhere in this Annual Report contains certain
forward-looking statements which reflect the current view of Gap Inc. (the
"Company") with respect to future events and financial performance. Wherever
used, the words "expect," "plan," "anticipate," "believe" and similar
expressions identify forward-looking statements.
Any such forward-looking statements are subject to risks and uncertainties
and the Company's future results of operations could differ materially from
historical results or current expectations. Some of these risks include, without
limitation, ongoing competitive pressures in the apparel industry, risks
associated with challenging international retail environments, changes in the
level of consumer spending or preferences in apparel, trade restrictions and
political or financial instability in countries where the Company's goods are
manufactured, disruption to operations from Year 2000 issues and/or other
factors that may be described in the Company's Annual Report on Form 10-K
and/or other filings with the Securities and Exchange Commission. Future
economic and industry trends that could potentially impact revenues and
profitability are difficult to predict.
The Company does not undertake to publicly update or revise its
forward-looking statements even if experience or future changes make it clear
that any projected results expressed or implied therein will not be realized.
Results of Operations
Net Sales
- - --------------------------------------------------------------------------------
Fifty-two Fifty-two Fifty-two
Weeks Ended Weeks Ended Weeks Ended
Jan. 30, 1999 Jan. 31, 1998 Feb. 1, 1997
- - --------------------------------------------------------------------------------
Net sales ($000) $9,054,462 $6,507,825 $5,284,381
Total net sales growth
percentage 39 23 20
Comparable store sales
growth percentage 17 6 5
Net sales per average
gross square foot $532 $463 $441
Square footage of gross
store space at year-end (000) 18,757 15,313 12,645
Number of:
New stores 318 298 203
Expanded stores 135 98 42
Closed stores 20 22 30
- - --------------------------------------------------------------------------------
The total net sales growth for all years presented was attributable primarily
to the increase in retail selling space, both through the opening of new stores
(net of stores closed) and the expansion of existing stores. An increase in
comparable store sales also contributed to net sales growth for all years
presented.
The increase in net sales per average square foot for 1998 and 1997 was
primarily attributable to increases in comparable store sales.
COST OF GOODS SOLD
AND OCCUPANCY EXPENSES
Cost of goods sold and occupancy expenses as a percentage of net sales decreased
3.1 and .4 percentage points in 1998 from 1997 and in 1997 from 1996,
respectively.
The decrease in 1998 from 1997 was attributable to a decrease in occupancy
expenses as a percentage of net sales combined with an increase in merchandise
margin. The decrease in occupancy expenses as a percentage of net sales was
primarily due to leverage achieved through comparable store sales growth. The
margin improvement was due to higher margins achieved on marked-down goods, as
well as to an increase in the percentage of merchandise sold at regular price.
The decrease in 1997 from 1996 was primarily attributable to a decrease in
occupancy expenses as a percentage of net sales, partially offset by a decrease
in merchandise margin. The decrease in occupancy expenses as a percentage of net
sales was primarily attributable to leverage achieved through comparable store
sales growth.
As a general business practice, 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 markdown and the amount of inventory affected.
Page 24 1998 Annual Report
Gap Inc. Gap Banana Republic Old Navy
OPERATING EXPENSES
Operating expenses as a percentage of net sales increased 1.4 percentage points
in 1998 from 1997 and 1.1 percentage points in 1997 from 1996.
In 1998, the increase was driven by significantly higher advertising/
marketing costs as part of the Company's continued brand development efforts,
partially offset by a decrease as a percentage of net sales in the write-off of
leasehold improvements and fixtures associated with the remodeling, relocation
and closing of certain stores planned for the next fiscal year, as well as to
leverage from comparable store sales growth.
In 1997, the increase was primarily attributable to both increases in
advertising/marketing costs and the write-off of leasehold improvements and
fixtures.
NET INTEREST EXPENSE/INCOME
The change in 1998 to net interest expense from net interest income in 1997 was
primarily due to the interest expense incurred for the full fiscal year related
to the $500 million of debt securities issued during the third quarter of 1997.
The Company's greater short-term borrowings in the last half of 1998 compared
to 1997 also contributed to the increase in interest expense. The decrease in
net interest income in 1997 from 1996 was due to the interest expense related to
the long-term debt and to a decrease in gross average investments.
INCOME TAXES
The effective tax rate was 37.5 percent in 1998 and 1997 and 39.5 percent in
1996. The decrease in the effective tax rate in 1997 was a result of the impact
of tax planning initiatives to support changing business needs.
Liquidity and Capital Resources
The following sets forth certain measures of the Company's liquidity:
- - --------------------------------------------------------------------------------
Fiscal Year
- - --------------------------------------------------------------------------------
1998 1997 1996
- - --------------------------------------------------------------------------------
Cash provided by
operating activities ($000) $1,394,161 $844,651 $834,953
Working capital ($000) 318,721 839,399 554,359
Current ratio 1.21:1 1.85:1 1.72:1
- - --------------------------------------------------------------------------------
For the fiscal year ended January 30, 1999, the increase in cash provided by
operating activities was due to an increase in net earnings and the timing of
payments for certain payables, partially offset by investments in merchandise
inventory. The decline in working capital and the current ratio was attributable
to an increase in payables driven by business growth combined with a decrease in
cash resulting from greater capital expenditures and share repurchases. For the
fiscal year ended January 31, 1998, the increase in cash provided by operating
activities was attributable to an increase in net earnings, offset by
investments in merchandise inventory and the timing of payments for income taxes
and certain payables.
The Company funds inventory expenditures during normal and peak periods
through a combination of cash flows from operations and short-term financing
arrangements. The Company's business follows a seasonal pattern, peaking over a
total of about 10 to 13 weeks during the Back-to-School and Holiday periods.
During 1998 and 1997, these periods accounted for 37 and 35 percent,
respectively, of the Company's annual sales.
The Company has committed credit facilities totaling $950 million, consisting
of an $800 million, 364-day revolving credit facility, and a $150 million,
5-year revolving credit facility through June 28, 2003. These credit facilities
provide for the issuance of up to $450 million in letters of credit. The Company
has additional uncommitted credit facilities of $400 million for the issuance of
letters of credit. At January 30, 1999, the Company had outstanding letters of
credit totaling approximately $677 million. The credit facilities also provide
backup for the Company's $500 million commercial paper program. During the last
half of fiscal 1998, the Company issued a total of $500 million of commercial
paper to cover short-term borrowing needs. The Company had no commercial paper
outstanding at January 30, 1999.
To provide financial flexibility, the Company filed a shelf registration
statement in January 1999 with the Securities and Exchange Commission for $500
million of debt securities. The net proceeds from any issuance are expected to
be used for general corporate purposes, including expansion of stores,
distribution centers and headquarters facilities, brand investment, development
of additional distribution channels and repurchases of the Company's common
stock pursuant to its ongoing repurchase program. No assurances can be given
that the Company will issue these debt securities.
In fiscal 1997, the Company issued $500 million of 6.9 percent ten-year debt
securities. The proceeds were used for general corporate purposes similar to
those described above.
In addition, during the first quarter of fiscal 1999, the Company's Japanese
subsidiary issued $50 million of ten-year
1998 Annual Report page 25
debt securities. The net proceeds are intended to be used for general corporate
purposes. The cash flows relating to the bonds were swapped for the equivalent
amounts in Japanese yen to minimize currency exposure.
Capital expenditures, net of construction allowances and dispositions,
totaled approximately $797 million in 1998. These expenditures resulted in a net
increase in store space of approximately 3.4 million square feet or 22 percent
due to the addition of 318 new stores, the expansion of 135 stores and the
remodeling of certain stores. Capital expenditures for 1997 and 1996 were $450
million and $359 million, respectively, resulting in a net increase in store
space of 2.7 million square feet in 1997 and 1.5 million square feet in 1996.
The increases in capital expenditures in 1998 from 1997 and in 1997 from 1996
were primarily attributable to the number of stores opened, expanded and
remodeled, as well as the expansion of headquarters facilities. The addition and
expansion of distribution centers also contributed to the 1998 increase.
For 1999, the Company expects capital expenditures to exceed $1 billion, net
of construction allowances. This represents the addition of 400 to 470 new
stores, the expansion of approximately 100 to 110 stores and the remodeling of
certain stores, as well as amounts for headquarters facilities, distribution
centers and equipment. The Company expects to fund such capital expenditures
with cash flow from operations and other sources of financing. Square footage
growth is expected to be in excess of 20 percent before store closings. New
stores are generally expected to be leased.
In 1997, the Company completed construction of a headquarters facility in San
Bruno, California for approximately $60 million. The Company acquired land in
1998 in San Bruno and San Francisco on which to construct additional
headquarters facilities. Construction commenced during the third quarter on the
San Francisco property.
Also during 1997, the Company commenced construction on a distribution center
for an estimated cost at completion of $60 million. The majority of the
expenditures for this facility were incurred in 1998. The facility is expected
to begin operations in early 1999.
On October 28, 1998, the Company's Board of Directors authorized a
three-for-two split of its common stock effective November 30, 1998, in the form
of a stock dividend for shareholders of record at the close of business on
November 11, 1998. All share and per share amounts in the accompanying
consolidated financial statements for all periods have been restated to reflect
the stock split.
In October 1998, the Board of Directors approved a program under which the
Company may purchase up to 45 million shares of its common stock. This program
follows an earlier 67.5 million share repurchase program, under which the
Company acquired 23.8 million shares for approximately $910 million during 1998.
To date under the earlier program 66.1 million shares have been repurchased for
approximately $1.7 billion.
During 1998, the Company entered into various put option contracts in
connection with the share repurchase program to hedge against stock price
fluctuations. The Company also continued to enter into foreign exchange forward
contracts to reduce exposure to foreign currency exchange risk involved in its
commitments to purchase merchandise for foreign operations. Additional
information on these contracts and agreements is presented in the Notes to
Consolidated Financial Statements (Note E). Quantitative and qualitative
disclosures about market risk for financial instruments are presented on
page 41.
Year 2000 Issue
The Year 2000 issue is primarily the result of computer programs using a two-
digit format, as opposed to four digits, to indicate the year. Such computer
systems will be unable to interpret dates beyond the year 1999, which could
cause a system failure or other computer errors, leading to a disruption in the
operation of such systems. In 1996, the Company established a project team to
coordinate existing Year 2000 activities and address remaining Year 2000 issues.
The team has focused its efforts on three areas: (1) information systems
software and hardware; (2) facilities and distribution equipment and (3) third-
party relationships.
The Program. The Company has adopted a five-phase Year 2000 program
consisting of: Phase I-identification and ranking of the components of the
Company's systems, equipment and suppliers that may be vulnerable to Year 2000
problems; Phase II-assessment of items identified in Phase I; Phase
III-remediation or replacement of non-compliant systems and components and
determination of solutions for non-compliant suppliers; Phase IV-testing of
systems and components following remediation and Phase V-developing contingency
plans to address the most
page 26 1998 Annual Report
Gap Inc. Gap Banana Republic Old Navy
reasonably likely worst case Year 2000 scenarios. The Company has completed
Phases I and II and continues to make progress according to plan on Phases III,
IV and V.
Information Systems Software and Hardware. The Company has completed Phase II
and has made substantial progress on Phase III. Phase IV testing is being
conducted concurrently with Phase III activities. Management believes that the
Company is on track to complete remediation, testing and implementation of its
individual information systems by mid-1999. Phase V contingency planning has
begun and is expected to be complete by the end of the third quarter of 1999.
Facilities and Distribution Equipment. The Company has completed Phase II and
is actively working on Phase III. Phase IV testing and Phase V contingency
planning are scheduled to begin in the first quarter of 1999.
Third-Party Relationships. The Company has completed Phase II and is actively
working on Phase III. Phase IV certification and Phase V contingency planning
are expected to begin in the first quarter of 1999.
Risks/Contingency Plans. Based on the assessment efforts to date, the
Company does not believe that the Year 2000 issue will have a material adverse
effect on its financial condition or results of operations. The Company operates
a large number of geographically dispersed stores and has a large supplier base
and believes that these factors will mitigate any adverse impact. The Company's
beliefs and expectations, however, are based on certain assumptions and
expectations that ultimately may prove to be inaccurate.
The Company has identified that a significant disruption in the product
supply chain represents the most reasonably likely worst case Year 2000
scenario. Potential sources of risk include (a) the inability of principal
suppliers or logistics providers to be Year 2000-ready, which could result in
delays in product deliveries from such suppliers or logistics providers and (b)
disruption of the distribution channel, including ports, transportation vendors
and the Company's own distribution centers as a result of a general failure of
systems and necessary infrastructure such as electricity supply. The Company is
preparing plans to flow inventory around an assumed period of disruption to the
supply chain, which could include accelerating selected critical products to
reduce the impact of significant failure.
The Company does not expect the costs associated with its Year 2000 efforts
to be substantial. Approximately $30 million has been budgeted to address the
Year 2000 issue, of which $16.5 million has been expensed through January 30,
1999. The Company's aggregate estimate does not include time and costs that may
be incurred by the Company as a result of the failure of any third parties,
including suppliers, to become Year 2000-ready or costs to implement any
contingency plans.
- - -------------------------------------------------------------------------------------------------------------------
Market Prices Cash Dividends
--------------------------------------------- ------------------
Fiscal 1998 1997 1998 1997
- - -------------------------------------------------------------------------------------------------------------------
High Low High Low
- - -------------------------------------------------------------------------------------------------------------------
1st Quarter $34 5/16 $26 5/16 $16 1/16 $12 11/16 $.0333 $.0333
2nd Quarter 44 15/16 33 11/16 19 7/8 13 5/8 .0333 .0333
3rd Quarter 45 5/16 30 1/4 23 13/16 18 11/16 .0333 .0333
4th Quarter 65 39 1/8 27 1/2 21 15/16 .0333(a) .0333
- - -------------------------------------------------------------------------------------------------------------------
Year $.1332 $.1332
- - -------------------------------------------------------------------------------------------------------------------
(a) Excludes a dividend of $.0333 per share declared in January 1999 but paid in
the first quarter of fiscal 1999.
The principal markets on which the Company's stock is traded are the New York
Stock Exchange and the Pacific Exchange. The number of holders of record of the
Company's stock as of March 12, 1999 was 7,967.
Management's Report on Financial Information
Management is responsible for the integrity and consistency of all financial
information presented in the Annual Report. The financial statements have been
prepared in accordance with generally accepted accounting principles and
necessarily include certain amounts based on Management's best estimates and
judgments.
In fulfilling its responsibility for the reliability of financial
information, Management has established and maintains accounting systems and
procedures appropriately supported by internal accounting controls. Such
controls include the selection and training of qualified personnel, an
organizational structure providing for division of responsibility, communication
of requirement for compliance with approved accounting control and business
practices and a program of internal audit. The extent of the Company's system
of internal accounting control recognizes that the cost should not exceed the
benefits derived and that the evaluation of those factors requires estimates and
judgments by Management. Although no system can ensure that all errors or
irregularities have been eliminated, Management believes that the internal
accounting controls in use provide reasonable assurance, at reasonable cost,
that assets are safeguarded against loss from unauthorized use or disposition,
that transactions are executed in accordance with Management's authorization
and that the financial records are reliable for preparing financial statements
and maintaining accountability for assets. The financial statements of the
Company have been audited by Deloitte & Touche LLP, independent auditors whose
report appears below.
The Audit and Finance Committee (the "Committee") of the Board of Directors
is comprised solely of directors who are not officers or employees of the
Company. The Committee is responsible for recommending to the Board of Directors
the selection of independent auditors. It meets periodically with Management,
the independent auditors and the internal auditors to assure that they are
carrying out their responsibilities. The Committee also reviews and monitors the
financial, accounting and auditing procedures of the Company in addition to
reviewing the Company's financial reports. Deloitte & Touche LLP and the
internal auditors have full and free access to the Committee, with and without
Management's presence.
Independent Auditors' Report
To the Shareholders and Board of Directors of The Gap, Inc.:
We have audited the accompanying consolidated balance sheets of The Gap, Inc.
and subsidiaries as of January 30, 1999 and January 31, 1998, and the related
consolidated statements of earnings, shareholders' equity and cash flows for
each of the three fiscal years in the period ended January 30, 1999. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company and its subsidiaries as
of January 30, 1999 and January 31, 1998, and the results of their operations
and their cash flows for each of the three fiscal years in the period ended
January 30, 1999 in conformity with generally accepted accounting principles.
/s/ Deloitte & Touche LLP
San Francisco, California
February 25, 1999
page 28 1998 Annual Report
Gap Inc. Gap Banana Republic Old Navy
Consolidated Statements of Earnings
Fifty-two Fifty-two Fifty-two
Weeks Ended Percentage Weeks Ended Percentage Weeks Ended Percentage
($000 except per share amounts) January 30, 1999 to Sales January 31, 1998 to Sales February 1, 1997 to Sales
- - ------------------------------------------------------------------------------------------------------------------------------------
Net sales $9,054,462 100.0% $6,507,825 100.0% $5,284,381 100.0%
Costs and expenses
Cost of goods sold and occupancy
expenses 5,318,218 58.7 4,021,541 61.8 3,285,166 62.2
Operating expenses 2,403,365 26.5 1,635,017 25.1 1,270,138 24.0
Net interest expense (income) 13,617 0.2 (2,975) 0.0 (19,450) (0.4)
------------------------------------------------------------------------------------------
Earnings before income taxes 1,319,262 14.6 854,242 13.1 748,527 14.2
Income taxes 494,723 5.5 320,341 4.9 295,668 5.6
------------------------------------------------------------------------------------------
Net earnings $ 824,539 9.1% $ 533,901 8.2% $ 452,859 8.6%
------------------------------------------------------------------------------------------
Weighted-average number of shares-basic 576,041,373 594,269,963 625,719,947
Weighted-average number of shares-diluted 602,916,255 615,301,137 640,900,830
------------------------------------------------------------------------------------------
Earnings per share-basic $1.43 $.90 $.72
Earnings per share-diluted 1.37 .87 .71
------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
1998 Annual Report page 29
Consolidated Balance Sheets
($000 except par value) January 30, 1999 January 31, 1998
- - -------------------------------------------------------------------------------------------------------------------
ASSETS
Current Assets
Cash and equivalents $ 565,253 $ 913,169
Merchandise inventory 1,056,444 733,174
Other current assets 250,127 184,604
---------------------------------
Total current assets 1,871,824 1,830,947
---------------------------------
Property and Equipment
Leasehold improvements 1,040,959 846,791
Furniture and equipment 1,601,572 1,236,450
Land and buildings 160,776 154,136
Construction-in-progress 245,020 66,582
---------------------------------
3,048,327 2,303,959
Accumulated depreciation and amortization (1,171,957) (938,713)
---------------------------------
Property and equipment, net 1,876,370 1,365,246
---------------------------------
Lease rights and other assets 215,725 141,309
---------------------------------
Total assets $ 3,963,919 $ 3,337,502
=================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Notes payable $ 90,690 $ 84,794
Accounts payable 684,130 416,976
Accrued expenses and other current liabilities 655,770 406,181
Income taxes payable 122,513 83,597
---------------------------------
Total current liabilities 1,553,103 991,548
---------------------------------
Long-Term Liabilities
Long-term debt 496,455 496,044
Deferred lease credits and other liabilities 340,682 265,924
---------------------------------
Total long-term liabilities 837,137 761,968
---------------------------------
Shareholders' Equity
Common stock $.05 par value
Authorized 1,500,000,000 shares; issued 664,997,475
and 659,884,262 shares; outstanding 571,973,354
and 589,699,542 shares 33,250 32,994
Additional paid-in capital 365,662 221,890
Retained earnings 3,121,360 2,392,750
Accumulated other comprehensive earnings (12,518) (15,230)
Deferred compensation (31,675) (38,167)
Treasury stock, at cost (1,902,400) (1,010,251)
---------------------------------
Total shareholders' equity 1,573,679 1,583,986
---------------------------------
Total liabilities and shareholders' equity $ 3,963,919 $ 3,337,502
=================================
See Notes to Consolidated Financial Statements.
page 30 1998 Annual Report
Gap Inc. Gap Banana Republic Old Navy
Consolidated Statements of Cash Flows
Fifty-two Fifty-two Fifty-two
Weeks Ended Weeks Ended Weeks Ended
($000) January 30, 1999 January 31, 1998 February 1, 1997
- - -------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net earnings $ 824,539 $ 533,901 $ 452,859
Adjustments to reconcile net earnings to
net cash provided by operating activities:
Depreciation and amortization/(a)/ 326,447 269,706 214,905
Tax benefit from exercise of stock options
and vesting of restricted stock 79,808 23,682 47,348
Deferred income taxes (34,766) (13,706) (28,897)
Change in operating assets and liabilities:
Merchandise inventory (322,287) (156,091) (93,800)
Prepaid expenses and other (77,292) (44,736) (16,355)
Accounts payable 265,296 63,532 88,532
Accrued expenses 231,178 107,365 87,974
Income taxes payable 38,805 (8,214) 25,706
Deferred lease credits and other long-term liabilities 62,433 69,212 56,681
-------------------------------------------------------
Net cash provided by operating activities 1,394,161 844,651 834,953
=======================================================
CASH FLOWS FROM INVESTING ACTIVITIES
Net maturity (purchase) of short-term investments - 174,709 (11,774)
Net purchase of long-term investments - (2,939) (40,120)
Net purchase of property and equipment (797,592) (465,843) (371,833)
Acquisition of lease rights and other assets (28,815) (19,779) (12,206)
-------------------------------------------------------
Net cash used for investing activities (826,407) (313,852) (435,933)
=======================================================
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in notes payable 1,357 44,462 18,445
Net issuance of long-term debt - 495,890 -
Issuance of common stock 49,421 30,653 37,053
Net purchase of treasury stock (892,149) (593,142) (466,741)
Cash dividends paid (76,888) (79,503) (83,854)
-------------------------------------------------------
Net cash used for financing activities (918,259) (101,640) (495,097)
=======================================================
Effect of exchange rate fluctuations on cash 2,589 (1,634) 2,155
-------------------------------------------------------
Net (decrease) increase in cash and equivalents (347,916) 427,525 (93,922)
Cash and equivalents at beginning of year 913,169 485,644 579,566
-------------------------------------------------------
Cash and equivalents at end of year $ 565,253 $ 913,169 $ 485,644
-------------------------------------------------------
See Notes to Consolidated Financial Statements.
(a) Includes amortization of restricted stock, discounted stock options and
discount on long-term debt.
1998 Annual Report page 31
Consolidated Statements of Shareholders' Equity
Common Stock
-------------------------------
($000 except share and per share amounts) Shares Amount Additional Paid-in Capital
- - -------------------------------------------------------------------------------------------------------------------------------
Balance at February 3, 1996 710,935,439 $35,547 $315,445
------------------------------------------------------------------
Issuance of common stock pursuant to stock option plans 3,580,141 179 19,634
Net issuance of common stock pursuant to management
incentive restricted stock plans 678,623 34 32,788
Tax benefit from exercise of stock options by employees
and from vesting of restricted stock 47,348
Foreign currency translation adjustments
Amortization of restricted stock
Purchase of treasury stock
Reissuance of treasury stock 6,969
Net earnings
Cash dividends ($.13 per share)
------------------------------------------------------------------
Balance at February 1, 1997 715,194,203 $35,760 $422,184
------------------------------------------------------------------
Issuance of common stock pursuant to stock option plans(a) 4,272,851 213 47,892
Net cancellations of common stock pursuant to management
incentive restricted stock plans (1,420,292) (71) (10,428)
Tax benefit from exercise of stock options by employees
and from vesting of restricted stock 23,682
Foreign currency translation adjustments
Amortization of restricted stock and discounted stock options
Purchase of treasury stock
Reissuance of treasury stock 7,344
Retirement of treasury stock (58,162,500) (2,908) (268,784)
Net earnings
Cash dividends ($.13 per share)
------------------------------------------------------------------
Balance at January 31, 1998 659,884,262 $32,994 $221,890
------------------------------------------------------------------
Issuance of common stock pursuant to stock option plans(b) 5,050,130 253 46,836
Net issuance of common stock pursuant to management
incentive restricted stock plans 63,083 3 4,362
Tax benefit from exercise of stock options by employees
and from vesting of restricted stock 79,808
Adjustments for foreign currency translation ($1,893) and
fluctuations in fair market value of financial instruments
($819)
Amortization of restricted stock and discounted stock options
Purchase of treasury stock
Reissuance of treasury stock 12,766
Net earnings
Cash dividends ($.17 per share (c))
------------------------------------------------------------------
Balance at January 30, 1999 664,997,475 $33,250 $365,662
------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
(a) Includes payout of cash for fractional shares resulting from the three-for-
two split of common stock effective December 22, 1997.
(b) Includes payout of cash for fractional shares resulting from the three-for-
two split of common stock effective November 30, 1998.
(c) Includes a dividend of $.0333 per share declared in January 1999 but paid in
the first quarter of fiscal 1999.
page 32 1998 Annual Report
Gap Inc. Gap Banana Republic Old Navy
Consolidated Statements of Shareholders' Equity
Accumulated Other
($000 except share and per share amounts) Retained Earnings Comprehensive Earnings Deferred Compensation
- - ------------------------------------------------------------------------------------------------------------------------------------
Balance at February 3, 1996 $1,569,347 $ (9,071) $(48,735)
- - ------------------------------------------------------------------------------------------------------------------------------------
Issuance of common stock pursuant to stock option plans (9,648)
Net issuance of common stock pursuant to management
incentive restricted stock plans (12,903)
Tax benefit from exercise of stock options by employees
and from vesting of restricted stock
Foreign currency translation adjustments 3,884
Amortization of restricted stock 23,448
Purchase of treasury stock
Reissuance of treasury stock
Net earnings 452,859
Cash dividends ($.13 per share) (83,854)
- - ------------------------------------------------------------------------------------------------------------------------------------
Balance at February 1, 1997 $1,938,352 $ (5,187) $(47,838)
- - ------------------------------------------------------------------------------------------------------------------------------------
Issuance of common stock pursuant to stock option plans(a) (18,166)
Net cancellations of common stock pursuant to management
incentive restricted stock plans 3,869
Tax benefit from exercise of stock options by employees
and from vesting of restricted stock
Foreign currency translation adjustments (10,043)
Amortization of restricted stock and discounted stock options 23,968
Purchase of treasury stock
Reissuance of treasury stock
Retirement of treasury stock
Net earnings 533,901
Cash dividends ($.13 per share) (79,503)
- - ------------------------------------------------------------------------------------------------------------------------------------
Balance at January 31, 1998 $2,392,750 $ (15,230) $(38,167)
- - ------------------------------------------------------------------------------------------------------------------------------------
Issuance of common stock pursuant to stock option plans(b) (10,351)
Net issuance of common stock pursuant to management
incentive restricted stock plans (3,873)
Tax benefit from exercise of stock options by employees
and from vesting of restricted stock
Adjustments for foreign currency translation ($1,893) and
fluctuations in fair market value of financial instruments ($819) 2,712
Amortization of restricted stock and discounted stock options 20,716
Purchase of treasury stock
Reissuance of treasury stock
Net earnings 824,539
Cash dividends ($.17 per share (c)) (95,929)
- - ------------------------------------------------------------------------------------------------------------------------------------
Balance at January 30, 1999 $3,121,360 $ (12,518) $(31,675)
- - ------------------------------------------------------------------------------------------------------------------------------------
Treasury Stock
----------------------------- Comprehensive
Shares Amount Total Earnings
- - ----------------------------------------------------------------------------------------------------------------------------
Balance at February 3, 1996 (63,502,475) $ (222,060) $1,640,473
- - ----------------------------------------------------------------------------------------------------------------------------
Issuance of common stock pursuant to stock option plans 10,165
Net issuance of common stock pursuant to management
incentive restricted stock plans 19,919
Tax benefit from exercise of stock options by employees
and from vesting of restricted stock 47,348
Foreign currency translation adjustments 3,884 $ 3,884
Amortization of restricted stock 23,448
Purchase of treasury stock (34,926,975) (468,246) (468,246)
Reissuance of treasury stock 899,243 1,505 8,474
Net earnings 452,859 452,859
Cash dividends ($.13 per share) (83,854)
- - ----------------------------------------------------------------------------------------------------------------------------
Balance at February 1, 1997 (97,530,207) $ (688,801) $1,654,470 $456,743
- - ----------------------------------------------------------------------------------------------------------------------------
Issuance of common stock pursuant to stock option plans(a) 29,939
Net cancellations of common stock pursuant to management
incentive restricted stock plans (6,630)
Tax benefit from exercise of stock options by employees
and from vesting of restricted stock 23,682
Foreign currency translation adjustments (10,043) (10,043)
Amortization of restricted stock and discounted stock options 23,968
Purchase of treasury stock (31,785,451) (598,149) (598,149)
Reissuance of treasury stock 968,438 5,007 12,351
Retirement of treasury stock 58,162,500 271,692 0
Net earnings 533,901 533,901
Cash dividends ($.13 per share) (79,503)
- - ----------------------------------------------------------------------------------------------------------------------------
Balance at January 31, 1998 (70,184,720) $(1,010,251) $1,583,986 $523,858
- - ----------------------------------------------------------------------------------------------------------------------------
Issuance of common stock pursuant to stock option plans(b) 36,738
Net issuance of common stock pursuant to management
incentive restricted stock plans 492
Tax benefit from exercise of stock options by employees
and from vesting of restricted stock 79,808
Adjustments for foreign currency translation ($1,893) and
fluctuations in fair market value of financial instruments ($819) 2,712 2,712
Amortization of restricted stock and discounted stock options 20,716
Purchase of treasury stock (23,809,650) (910,387) (910,387)
Reissuance of treasury stock 970,249 18,238 31,004
Net earnings 824,539 824,539
Cash dividends ($.17 per share (c)) (95,929)
- - ----------------------------------------------------------------------------------------------------------------------------
Balance at January 30, 1999 (93,024,121) $(1,902,400) $1,573,679 $827,251
- - ----------------------------------------------------------------------------------------------------------------------------
1998 Annual Report page 33
NOTE A: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
For the Fifty-two Weeks ended January 30, 1999 (fiscal 1998), the Fifty-two
Weeks ended January 31, 1998 (fiscal 1997) and the Fifty-two Weeks ended
February 1, 1997 (fiscal 1996).
Gap Inc. (the "Company") is a global specialty retailer which operates stores
selling casual apparel, personal care and other accessories for men, women and
children under a variety of brand names including Gap, Banana Republic and Old
Navy. Its principal markets consist of the United States, Canada, Europe and
Asia with the United States being the most significant.
On October 28, 1998, the Company's Board of Directors authorized a three-for-
two split of its common stock effective November 30, 1998, in the form of a
stock dividend for shareholders of record at the close of business on
November 11, 1998. All share and per share amounts in the accompanying
consolidated financial statements for all periods have been restated to reflect
the stock split.
The consolidated financial statements include the accounts of the Company and
its subsidiaries. Intercompany accounts and transactions have been eliminated.
The preparation of financial statements in conformity with generally accepted
accounting principles requires Management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period. Actual
results could differ from those estimates.
Cash and equivalents represent cash and short-term, highly liquid investments
with original maturities of three months or less.
Merchandise inventory is stated at the lower of FIFO (first-in, first-out)
cost or market.
Property and equipment are stated at cost. Depreciation and amortization are
computed using the straight-line method over the estimated useful lives of the
related assets.
Lease rights are recorded at cost and are amortized over the estimated useful
lives of the respective leases, not to exceed 20 years.
Costs associated with the opening or remodeling of stores, such as
pre-opening rent and payroll, are expensed as incurred. The net book value of
fixtures and leasehold improvements for stores scheduled to be closed or
expanded within the next fiscal year is charged against current earnings.
Costs associated with the production of advertising, such as writing copy,
printing and other costs, are expensed as incurred. Costs associated with
communicating advertising that has been produced, such as television and
magazine, are expensed when the advertising first takes place. Direct response
costs of catalogs are capitalized and amortized over the expected lives of the
related catalogs, not to exceed six months. Advertising costs were $419 million,
$175 million and $96 million in fiscal 1998, 1997 and 1996, respectively.
Deferred income taxes arise from temporary differences between the tax basis
of assets and liabilities and their reported amounts in the consolidated
financial statements.
Translation adjustments result from translating foreign subsidiaries'
financial statements into U.S. dollars. Balance sheet accounts are translated at
exchange rates in effect at the balance sheet date. Income statement accounts
are translated at average exchange rates during the year. Resulting translation
adjustments are included in shareholders' equity.
The Company accounts for stock-based awards using the intrinsic value-based
method under Accounting Principles Board (APB) Opinion No. 25, Accounting for
Stock Issued to Employees, and has provided pro forma disclosures of net
earnings and earnings per share in accordance with the provisions of Statement
of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based
Compensation. Restricted stock and discounted stock options represent deferred
compensation and are shown as a reduction of shareholders' equity.
In fiscal 1998, the Company adopted SFAS No. 130, Reporting Comprehensive
Income, which requires that an enterprise report, by major components and as a
single total, the change in its net assets during the period from non-owner
sources. The components of comprehensive earnings are shown in the Consolidated
Statements of Shareholders' Equity.
The Company also adopted SFAS No. 131, Disclosures About Segments of an
Enterprise and Related Information, which establishes annual and interim
reporting standards for an enterprise's operating segments and related
disclosures about its products, services, geographic areas and major customers.
The Company has one reportable segment given the similarities of economic
characteristics between the operations represented by the Company's three
brands. Revenues of international retail operations represent 10.1 percent, 9.7
percent and 9.1 percent of Gap Inc.'s revenues for fiscal
Page 34 1998 Annual Report
1998, 1997 and 1996, respectively. Long-term assets of international operations,
including retail and sourcing, represent 14.3 percent and 13.4 percent of Gap
Inc.'s long-term assets for fiscal 1998 and 1997, respectively.
The Company adopted SFAS No. 133, Accounting for Derivative Instruments and
Hedging Activities, on November 1, 1998. In accordance with the transition
provisions of SFAS No. 133, the Company recorded the fair value of derivatives
designated as fair-value and cash-flow hedges on the balance sheet. The Company
also recorded a corresponding offset within the balance sheet to reflect the
fair value of the hedged firm commitments. The net impact of the cumulative-
effect adjustment for fair-value hedges was not material. The Company also
recorded an immaterial cumulative-effect adjustment in comprehensive earnings to
recognize at fair value all derivatives designated as cash-flow hedges.
Certain reclassifications have been made to the 1996 and 1997 financial
statements to conform with the 1998 financial statements.
NOTE B: DEBT AND OTHER CREDIT ARRANGEMENTS
The Company has committed credit facilities totaling $950 million, consisting of
an $800 million, 364-day revolving credit facility, and a $150 million, 5-year
revolving credit facility through June 28, 2003. These credit facilities provide
for the issuance of up to $450 million in letters of credit. The Company has
additional uncommitted credit facilities of $400 million for the issuance of
letters of credit. At January 30, 1999, the Company had outstanding letters of
credit totaling $677,305,000.
Borrowings under the Company's credit agreements are subject to the Company
not exceeding a certain debt ratio. The Company was in compliance with this debt
covenant at January 30, 1999.
During fiscal 1997, the Company issued long-term debt which consists of $500
million of 6.9 percent unsecured notes, due September 15, 2007. Interest on the
notes is payable semi-annually. The fair value of the notes at January 30, 1999
was approximately $552 million, based on the current rates at which the Company
could borrow funds with similar terms and remaining maturities. The balance of
the debt is net of unamortized discount.
Gross interest payments were $47,415,000, $8,399,000 and $2,800,000 in fiscal
1998, 1997 and 1996, respectively.
NOTE C: INCOME TAXES
Income taxes consisted of the following:
- - --------------------------------------------------------------------------------
Fifty-two Fifty-two Fifty-two
Weeks Ended Weeks Ended Weeks Ended
($000) Jan. 30,1999 Jan. 31, 1998 Feb. 1, 1997
- - --------------------------------------------------------------------------------
Currently Payable
Federal $438,110 $279,068 $266,063
State 55,716 33,384 36,167
Foreign 35,663 21,595 22,335
- - --------------------------------------------------------------------------------
Total currently payable 529,489 334,047 324,565
- - --------------------------------------------------------------------------------
Deferred
Federal (29,163) (14,832) (23,980)
State and foreign (5,603) 1,126 (4,917)
- - --------------------------------------------------------------------------------
Total deferred (34,766) (13,706) (28,897)
- - --------------------------------------------------------------------------------
Total provision $494,723 $320,341 $295,668
- - --------------------------------------------------------------------------------
The foreign component of pretax earnings before eliminations and corporate
allocations in fiscal 1998, 1997 and 1996 was $190,864,000, $84,487,000 and
$82,220,000, respectively. No provision was made for U.S. income taxes on the
undistributed earnings of the foreign subsidiaries as it is the Company's
intention to utilize those earnings in the foreign operations for an indefinite
period of time or repatriate such earnings only when tax effective to do so.
Undistributed earnings of foreign subsidiaries were $371,886,000 at January 30,
1999.
The difference between the effective income tax rate and the United States
federal income tax rate is summarized as follows:
- - --------------------------------------------------------------------------------
Fifty-two Fifty-two Fifty-two
Weeks Ended Weeks Ended Weeks Ended
Jan. 30,1999 Jan. 31, 1998 Feb. 1, 1997
- - --------------------------------------------------------------------------------
Federal tax rate 35.0% 35.0% 35.0%
State income taxes,
less federal benefit 2.5 3.2 4.4
Other 0.0 (0.7) 0.1
- - --------------------------------------------------------------------------------
Effective tax rate 37.5% 37.5% 39.5%
- - --------------------------------------------------------------------------------
Deferred tax assets (liabilities) consisted of the following:
- - --------------------------------------------------------------------------------
($000) Jan. 30, 1999 Jan. 31, 1998
- - --------------------------------------------------------------------------------
Compensation and benefits accruals $43,509 $31,367
Scheduled rent 54,687 44,451
Inventory capitalization 40,976 28,776
Nondeductible accruals 10,257 20,003
Other 22,031 17,854
- - --------------------------------------------------------------------------------
Gross deferred tax assets 171,460 142,451
- - --------------------------------------------------------------------------------
Depreciation (4,058) (9,553)
Other (6,083) (6,345)
- - --------------------------------------------------------------------------------
Gross deferred tax liabilities (10,141) (15,898)
- - --------------------------------------------------------------------------------
Net deferred tax assets $161,319 $126,553
- - --------------------------------------------------------------------------------
1998 Annual Report page 35
Net deferred tax assets at January 30, 1999 and January 31, 1998 are included in
Other Current Assets ($101,048,000 and $66,120,000, respectively), and Lease
Rights and Other Assets ($60,271,000 and $60,433,000, respectively) in the
Consolidated Balance Sheets. Income tax payments were $410,919,000, $320,744,000
and $249,968,000 in fiscal 1998, 1997 and 1996, respectively.
NOTE D: LEASES
The Company leases most of its store premises and headquarters facilities and
some of its distribution centers. These leases expire at various dates through
2017.
The aggregate minimum non-cancelable annual lease payments under leases in
effect on January 30, 1999 are as follows:
- - --------------------------------------------------------------------------------
Fiscal Year ($000)
- - --------------------------------------------------------------------------------
1999 $ 511,335
2000 496,589
2001 472,029
2002 440,932
2003 385,126
Thereafter 1,322,334
- - --------------------------------------------------------------------------------
Total minimum lease commitment $3,628,345
- - --------------------------------------------------------------------------------
Many leases entered into by the Company include options that may extend the
lease term beyond the initial commitment period, subject to terms agreed to at
lease inception. Some leases also include early termination options which can be
exercised under specific conditions. If conditions did not warrant invoking
early termination of any leases, and all renewal options were exercised for
current lease agreements, the total lease commitment for the Company would be
approximately $5.7 billion.
For leases that contain predetermined fixed escalations of the minimum
rentals, the Company recognizes the related rental expense on a straight-line
basis and records the difference between the recognized rental expense and
amounts payable under the leases as deferred lease credits. At January 30, 1999
and January 31, 1998, this liability amounted to $154,897,000 and $129,981,000,
respectively.
Cash or rent abatements received upon entering into certain store leases are
recognized on a straight-line basis as a reduction to rent expense over the
lease term. The unamortized portion is included in deferred lease credits.
Some of the leases relating to stores in operation at January 30, 1999
contain renewal options for periods ranging up to 30 years. Many leases also
provide for payment of operating expenses, real estate taxes and for additional
rent based on a percentage of sales. No lease directly imposes any restrictions
relating to leasing in other locations (other than radius clauses).
Rental expense for all operating leases was as follows:
- - --------------------------------------------------------------------------------
Fifty-two Fifty-two Fifty-two
Weeks Ended Weeks Ended Weeks Ended
($000) Jan. 30,1999 Jan. 31, 1998 Feb. 1, 1997
- - --------------------------------------------------------------------------------
Minimum rentals $460,715 $391,472 $337,487
Contingent rentals 75,601 38,657 30,644
- - --------------------------------------------------------------------------------
Total $536,316 $430,129 $368,131
- - --------------------------------------------------------------------------------
NOTE E: FINANCIAL INSTRUMENTS
Foreign Exchange Forward Contracts
The Company operates in foreign countries which exposes it to market risk
associated with foreign currency exchange rate fluctuations. The Company's risk
management policy is to hedge substantially all merchandise purchases for
foreign operations through the use of foreign exchange forward contracts to
minimize this risk. At January 30, 1999, the Company had contracts maturing at
various dates through 1999 to sell the equivalent of $309,775,000 in foreign
currencies (83,200,000 British pounds, 171,100,000 Canadian dollars,
41,582,379,856 Italian lire, 3,254,000,000 Japanese yen and 1,334,870,281
Spanish pesetas) at the contracted rates.
Changes in the fair value of forward contracts designated as fair-value
hedges, along with the offsetting changes in fair value of the related firm
commitments to purchase foreign merchandise, are recorded in cost of sales in
the current period. Changes in the fair value of forward contracts designated as
cash-flow hedges are recorded as a component of comprehensive earnings, and are
recognized in earnings when the hedged merchandise inventory is paid for. The
related balance included in comprehensive earnings at January 30, 1999 will be
recognized in earnings over the next 12 months. The critical terms of the
forward contracts and the respective firm commitments and forecasted foreign
purchase transactions are essentially the same. As a result, there were no
amounts reflected in fiscal 1998 earnings resulting from hedge ineffectiveness.
NOTE F: EMPLOYEE BENEFIT AND INCENTIVE STOCK COMPENSATION PLANS
Retirement Plans
The Company has a qualified defined contribution retirement plan, called
GapShare, which is available to employees who meet certain age and service
requirements. This plan permits employees to make contributions up to the
maximum limits allowable under the Internal Revenue Code. Under the plan,
page 36 1998 Annual Report
the Company matches all or a portion of the employee's contributions under a
predetermined formula. The Company's contributions vest immediately. Company
contributions to the retirement plan in 1998, 1997 and 1996 were $14,284,000,
$12,907,000 and $11,427,000, respectively.
A nonqualified Executive Deferred Compensation Plan was established on
January 1, 1999 which allows eligible employees to defer compensation up to a
maximum amount. This plan superseded an earlier nonqualified Executive Deferred
Compensation Plan, established on January 1, 1994, and a nonqualified Executive
Capital Accumulation Plan, established on April 1, 1994. The Company does not
match employees' contributions under the current plan.
A Deferred Compensation Plan was established on August 26, 1997 for
nonemployee members of the Board of Directors. Under this plan, Board members
may elect to defer receipt on a pre-tax basis of eligible compensation received
for serving as nonemployee directors of the Company. In exchange for
compensation deferred, Board members are granted discounted stock options to
purchase shares of the Company's common stock. All options are fully
exercisable upon the date granted and expire seven years after grant or one year
after retirement from the Board, if earlier. The Company may issue up to 450,000
shares under the plan.
Incentive Stock Compensation Plans
The 1996 Stock Option and Award Plan (the "Plan") was established on March 26,
1996. The Board authorized 62,227,561 shares for issuance under the Plan, which
includes shares available under the Management Incentive Restricted Stock Plan
("MIRSP") and an earlier stock option plan established in 1981, both of which
were superseded by the Plan. The Plan empowers the Compensation and Stock Option
Committee of the Board of Directors (the "Committee") to award compensation
primarily in the form of nonqualified stock options or restricted stock to key
employees. Stock options generally expire ten years from the grant date or one
year after the date of retirement, if earlier. Stock options generally vest over
a three-year period, with shares becoming exercisable in full on the third
anniversary of the grant date. Nonqualified stock options are generally issued
at fair market value but may be issued at prices less than the fair market value
at the date of grant or at other prices as determined by the Committee. Total
compensation cost for those stock options issued at less than fair market value
and for the restricted shares issued was $20,845,000, $17,170,000 and
$22,248,000 in 1998, 1997 and 1996, respectively.
In 1998, the Company established a stock option plan for non-officers, called
Stock Up On Success, under which eligible employees may receive nonqualified
stock options. The Board of Directors authorized 4,000,000 shares for issuance
under Stock Up On Success. Stock options under the plan must be issued at not
less than fair market value. On February 25, 1999, options to purchase 983,400
shares were granted to approximately 19,000 employees under the plan. These
stock options have a vesting period of 11/2 years and expire ten years after the
grant date.
Employee Stock Purchase Plan
The Company has an Employee Stock Purchase Plan under which all eligible
employees may purchase common stock of the Company at 85 percent of the lower of
the closing price of the Company's common stock on the grant date or the
purchase date on the New York Stock Exchange Composite Transactions Index.
Employees pay for their stock purchases through payroll deductions at a rate
equal to any whole percentage from 1 percent to 15 percent. There were 960,410
shares issued under the plan during fiscal 1998, 968,438 during 1997 and 899,243
during 1996. All shares were acquired from reissued treasury stock. At
January 30, 1999, there were 5,304,458 shares reserved for future subscriptions.
NOTE G: SHAREHOLDERS' EQUITY AND STOCK OPTIONS
Common and Preferred Stock
The Company is authorized to issue 60,000,000 shares of Class B common stock
which is convertible into shares of common stock on a share-for-share basis;
transfer of the shares is restricted. In addition, the holders of the Class B
common stock have six votes per share on most matters and are entitled to a
lower cash dividend. No Class B shares have been issued.
The Board of Directors is authorized to issue 30,000,000 shares of one or
more series of preferred stock and to establish at the time of issuance the
issue price, dividend rate, redemption price, liquidation value, conversion
features and such other terms and conditions of each series (including voting
rights) as the Board of Directors deems appropriate, without further action on
the part of the shareholders. No preferred shares have been issued.
In October 1998, the Board of Directors approved a program under which the
Company may purchase up to 45 million shares of its common stock. This program
follows an earlier 67.5 million share repurchase program, under which the
Company acquired 23.8 million shares for approximately
1998 Annual Report page 37
$910 million during 1998. To date under the earlier program 66.1 million shares
have been repurchased for approximately $1.7 billion.
Stock Options
Under the Company's stock option plans, nonqualified options to purchase common
stock are granted to officers, directors and employees at exercise prices equal
to the fair market value of the stock at the date of grant or at other prices as
determined by the Compensation and Stock Option Committee of the Board of
Directors.
Stock option activity for all employee benefit plans was as follows:
- - --------------------------------------------------------------------------------
Weighted-Average
Shares Exercise Price
- - --------------------------------------------------------------------------------
Balance at February 3, 1996 35,190,954 $ 7.61
- - --------------------------------------------------------------------------------
Granted 14,046,165 13.73
Exercised (3,580,141) 5.53
Canceled (1,797,912) 9.90
- - --------------------------------------------------------------------------------
Balance at February 1, 1997 43,859,066 $ 9.64
- - --------------------------------------------------------------------------------
Granted 17,088,797 14.41
Exercised (4,273,551) 7.10
Canceled (3,838,943) 10.67
- - --------------------------------------------------------------------------------
Balance at January 31, 1998 52,835,369 $11.31
- - --------------------------------------------------------------------------------
Granted 18,963,355 32.18
Exercised (5,068,828) 7.43
Canceled (1,891,206) 17.91
- - --------------------------------------------------------------------------------
Balance at January 30, 1999 64,838,690 $17.53
- - --------------------------------------------------------------------------------
Outstanding options at January 30, 1999 have expiration dates ranging from
March 26, 1999 to January 26, 2009.
At January 30, 1999, the Company reserved 88,981,648 shares of its common
stock, including 69,260 treasury shares, for the exercise of stock options.
There were 24,142,958 and 37,289,148 shares available for granting of options at
January 30, 1999 and January 31, 1998, respectively. Options for 7,275,359,
6,449,771 and 6,559,833 shares were exercisable as of January 30, 1999, January
31, 1998 and February 1, 1997, respectively, and had a weighted-average exercise
price of $8.26, $7.77 and $6.01 for those respective periods.
The Company accounts for its stock option and award plans in accordance with
APB Opinion No. 25, under which no compensation cost has been recognized for
stock option awards granted at fair market value. Had compensation cost for the
Company's stock-based compensation plans been determined based on the fair
value at the grant dates for awards under those plans in accordance with the
provisions of SFAS No. 123, Accounting for Stock-Based Compensation, the
Company's net earnings and earnings per share would have been reduced to the
pro forma amounts indicated below. The effects of applying SFAS No. 123 in this
pro forma disclosure are not indicative of future amounts. SFAS No. 123 does not
apply to awards prior to fiscal year 1995. Additional awards in future years are
anticipated.
- - --------------------------------------------------------------------------------
Fifty-two Fifty-two Fifty-two
Weeks Ended Weeks Ended Weeks Ended
Jan. 30,1999 Jan. 31, 1998 Feb. 1, 1997
- - --------------------------------------------------------------------------------
Net earnings ($000)
As reported $824,539 $533,901 $452,859
Pro forma 772,062 507,966 437,232
- - --------------------------------------------------------------------------------
Earnings per share
As reported-basic $1.43 $.90 $.72
Pro forma-basic 1.34 .85 .70
As reported-diluted 1.37 .87 .71
Pro forma-diluted 1.28 .83 .68
- - --------------------------------------------------------------------------------
The weighted-average fair value of the stock options granted during fiscal
1998, 1997 and 1996 was $11.25, $5.84 and $4.98, respectively. The fair value of
each option granted is estimated on the date of the grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions for grants in 1998: dividend yield of .4 percent; expected price
volatility of 32 percent; risk-free interest rates ranging from 5.3 percent to
5.7 percent and expected lives between 3.9 and 6.1 years. The fair value of
stock options granted in 1997 was based on the following weighted-average
assumptions: dividend yield of .7 percent; expected price volatility of 31
percent; risk-free interest rates ranging from 5.9 percent to 7.0 percent and
expected lives between 3.9 and 5.8 years. The fair value of stock options
granted prior to 1997 was based on the following weighted-average assumptions:
dividend yield of 1.0 percent; expected price volatility of 30 percent;
risk-free interest rates ranging from 5.5 percent to 6.5 percent and expected
lives between 3.6 and 5.8 years.
page 38 1998 Annual Report
The following table summarizes information about stock options outstanding at January 30, 1999:
- - -----------------------------------------------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
----------------------------------------------------------------- ------------------------------------
Number Outstanding Weighted-Average Remaining Weighted-Average Number Exercisable Weighted-Average
Range of Exercise Prices at Jan. 30, 1999 Contractual Life (in years) Exercise Price at Jan. 30, 1999 Exercise Price
- - -----------------------------------------------------------------------------------------------------------------------------------
$ 5.45 to $ 8.69 19,519,642 4.71 $ 7.91 4,648,267 $ 6.89
8.94 to 13.91 14,180,163 7.30 12.88 2,395,097 9.86
13.92 to 22.73 12,926,859 7.71 16.06 164,610 15.13
22.75 to 62.22 18,212,026 9.15 32.49 67,385 29.48
- - -----------------------------------------------------------------------------------------------------------------------------------
$ 5.45 to $62.22 64,838,690 7.12 $17.53 7,275,359 $ 8.26
- - -----------------------------------------------------------------------------------------------------------------------------------
NOTE H: EARNINGS PER SHARE
Under SFAS No. 128, the Company provides dual presentation of EPS on a basic and
diluted basis. The Company's granting of certain stock options and restricted
stock resulted in potential dilution of basic EPS. The following summarizes the
effects of the assumed issuance of dilutive securities on weighted-average
shares for basic EPS.
- - --------------------------------------------------------------------------------
Fifty-two Fifty-two Fifty-two
Weeks Ended Weeks Ended Weeks Ended
Jan. 30,1999 Jan. 31, 1998 Feb. 1, 1997
- - --------------------------------------------------------------------------------
Weighted-average number
of shares-basic 576,041,373 594,269,963 625,719,947
Incremental shares from
assumed issuance of:
Stock options 23,560,445 15,056,550 8,395,829
Restricted stock 3,314,437 5,974,624 6,785,054
- - --------------------------------------------------------------------------------
Weighted-average number
of shares-diluted 602,916,255 615,301,137 640,900,830
- - --------------------------------------------------------------------------------
The number of incremental shares from the assumed issuance of stock options
and restricted stock is calculated applying the treasury stock method.
Excluded from the above computation of weighted-average shares for diluted
EPS were options to purchase 18,175 shares of common stock during fiscal 1998,
660,095 during 1997 and 7,627,467 during 1996. Issuance of these securities
would have resulted in an antidilutive effect on EPS.
NOTE I: RELATED PARTY TRANSACTIONS
The Company has an agreement with Fisher Development, Inc. (FDI), wholly owned
by the brother of the Company's chairman, setting forth the terms under which
FDI may act as general contractor in connection with the Company's construction
activities. FDI acted as general contractor for 302, 266 and 177 new stores'
leasehold improvements and fixtures during fiscal 1998, 1997 and 1996,
respectively. In the same respective years, FDI supervised construction of 135,
97 and 38 expansions, as well as remodels of existing stores and headquarters
facilities. Total cost of construction was $342,030,000, $233,777,000 and
$111,871,000, including profit and overhead costs of $28,877,000, $16,845,000
and $10,751,000, for fiscal 1998, 1997 and 1996, respectively. At January 30,
1999 and January 31, 1998, amounts due to FDI were $15,302,000 and $10,318,000,
respectively. The terms and conditions of the agreement with FDI are reviewed
annually by the Audit and Finance Committee of the Board of Directors.
1998 Annual Report page 39
NOTE J: QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Fiscal 1998
- - ---------------------------------------------------------------------------------------------------------------------------------
Thirteen Thirteen Thirteen Thirteen Fifty-two
Weeks Ended Weeks Ended Weeks Ended Weeks Ended Weeks Ended
($000 except per share amounts) May 2, 1998 Aug. 1, 1998 Oct. 31, 1998 Jan. 30, 1999 Jan. 30, 1999
- - ---------------------------------------------------------------------------------------------------------------------------------
Net sales $1,719,712 $1,904,970 $2,399,948 $3,029,832 $9,054,462
Gross profit 688,708 769,805 1,023,943 1,253,788 3,736,244
Net earnings 136,066 136,874 237,749 313,850 824,539
Earnings per share-basic .23 .23 .42 .55 1.43
Earnings per share-diluted .22 .22 .40 .53 1.37
- - ---------------------------------------------------------------------------------------------------------------------------------
Fiscal 1997
- - ---------------------------------------------------------------------------------------------------------------------------------
Thirteen Thirteen Thirteen Thirteen Fifty-two
Weeks Ended Weeks Ended Weeks Ended Weeks Ended Weeks Ended
($000 except per share amounts) May 3, 1997 Aug. 2, 1997 Nov. 1, 1997 Jan. 31, 1998 Jan. 31, 1998
- - ---------------------------------------------------------------------------------------------------------------------------------
Net sales $1,231,186 $1,345,221 $1,765,939 $2,165,479 $6,507,825
Gross profit 442,060 462,135 721,266 860,823 2,486,284
Net earnings 84,304 69,458 164,523 215,616 533,901
Earnings per share-basic .14 .12 .28 .37 .90
Earnings per share-diluted .14 .11 .27 .36 .87
- - ---------------------------------------------------------------------------------------------------------------------------------
page 40 1998 Annual Report
Quantitative and Qualitative Disclosures About Market Risk
The table below provides information about the Company's market sensitive
financial instruments as of January 30, 1999 and January 31, 1998.
The Company purchases foreign exchange forward contracts to hedge
substantially all merchandise purchases made by foreign operations. These
contracts are entered into with large reputable financial institutions, thereby
minimizing the risk of credit loss. Further discussion of these contracts
appears in the Notes to the Consolidated Financial Statements (Note E).
During fiscal 1997, the Company issued $500 million of unsecured notes, due
September 15, 2007, with a fixed interest rate of 6.9 percent. By entering into
the fixed-rate notes, the Company avoided interest rate risk from variable rate
fluctuations.
A portion of the Company's fixed-rate short-term borrowings used to finance
foreign operations is denominated in foreign currencies. By borrowing and
repaying the loans in local currencies, the Company avoided the risk associated
with exchange rate fluctuations.
- - -----------------------------------------------------------------------------------------------------------------------------------
January 30, 1999 January 31, 1998
--------------------------------------------------- ---------------------------------------------------
Notional Amount of Notional Amount of
Average Forward Contracts Average Forward Contracts
($000) Contract Rate(a) in U.S. Dollars Fair Value(b) Contract Rate(a) in U.S. Dollars Fair Value(b)
- - ----------------------------------------------------------------------------- ---------------------------------------------------
Foreign exchange
forward contracts(c)
British pounds .61 $137,222 $136,581 .60 $ 33,394 $ 33,269
Canadian dollars 1.51 112,967 112,228 1.40 32,984 31,757
Italian lire 1,700.06 24,459 25,052 1,743.25 35,924 35,383
Japanese yen 126.24 25,776 28,197 120.52 12,803 12,266
Spanish pesetas 142.75 9,351 9,189 151.98 8,125 8,112
- - -----------------------------------------------------------------------------------------------------------------------------------
Total foreign exchange forward contracts $309,775 $311,247 $123,230 $120,787
- - -----------------------------------------------------------------------------------------------------------------------------------
- - -----------------------------------------------------------------------------------------------------------------------------------
January 30, 1999 January 31, 1998
--------------------------------------------------- ---------------------------------------------------
Carrying Amount in Carrying Amount in
($000) U.S. Dollars Fair Value(d) U.S. Dollars Fair Value(d)
- - -----------------------------------------------------------------------------------------------------------------------------------
Notes payable $496,455 $551,818 $496,044 $526,128
- - -----------------------------------------------------------------------------------------------------------------------------------
(a) Currency per U.S. dollar.
(b) Calculated using forward spot rates at the dates presented.
(c) All contracts mature within one year.
(d) Based on the rates at which the Company could borrow funds with similar
terms and remaining maturities at the dates presented.
1998 Annual Report page 41