10-K 1 fy201710-k.htm 10-K Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
þ
Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended February 3, 2018
¨
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the transition period from                      to                     
Commission File Number 1-7562 
THE GAP, INC.
(Exact name of registrant as specified in its charter)
Delaware
94-1697231
(State of Incorporation)
(I.R.S. Employer Identification No.)
Two Folsom Street, San Francisco, California
94105
(Address of principal executive offices)
(Zip code)
Registrant’s telephone number, including area code: (415) 427-0100
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $0.05 par value
The New York Stock Exchange
(Title of class)
(Name of exchange where registered)
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ   No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨   No þ
Indicate by check mark whether the 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 þ   No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ   No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act:
Large accelerated filer
þ
Accelerated filer
¨

 Non-accelerated filer
¨

 Smaller reporting company
¨

Emerging growth company
¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨  No þ
The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of July 28, 2017 was approximately $5 billion based upon the last price reported for such date in the NYSE-Composite transactions.
The number of shares of the registrant’s common stock outstanding as of March 14, 2018 was 389,318,839.
Documents Incorporated by Reference
Portions of the registrant’s Proxy Statement for the Annual Meeting of Shareholders to be held on May 22, 2018 (hereinafter referred to as the “2018 Proxy Statement”) are incorporated into Part III.




Special Note on Forward-Looking Statements
This Annual Report on Form 10-K contains forward-looking statements within the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. All statements other than those that are purely historical are forward-looking statements. Words such as “expect,” “anticipate,” “believe,” “estimate,” “intend,” “plan,” “project,” and similar expressions also identify forward-looking statements. Forward-looking statements include, but are not limited to, statements regarding the following:
investing in the business, including in digital and customer capabilities to support growth, while maintaining operating expense discipline and driving efficiency through our productivity initiative;
integrating social and environmental sustainability into business practices;
attracting and retaining great talent in our businesses and functions;
transforming our product to market process to more fully leverage our scale;
continuing our investment in customer experience to drive higher customer engagement and loyalty;
net store openings in fiscal 2018;
the impact of the 52-week fiscal year in fiscal 2018 compared with the 53-week fiscal year in fiscal 2017;
gross margins for our foreign subsidiaries, net of the impact from our merchandise hedge program, in fiscal 2018;
current cash balances and cash flows being sufficient to support our business operations, including growth initiatives, planned capital expenditures, and repayment of debt;
ability to supplement near-term liquidity, if necessary, with our $500 million revolving credit facility or other available market instruments;
the impact of the seasonality of our operations combined with the calendar shift of weeks in fiscal 2018 compared with fiscal 2017;
dividend payments in fiscal 2018;
the impact if actuals differ substantially from estimates and assumptions used in accounting calculations and policies;
the impact of recent accounting pronouncements;
the impact of the potential settlement of outstanding tax matters;
unrealized gains and losses from designated cash flow hedges;
recognition of unrecognized share-based compensation expense;
the impact of the Tax Cuts and Jobs Act of 2017, including changes to provisional estimates;
total gross unrecognized tax benefits;
the impact of losses due to indemnification obligations;
the outcome of proceedings, lawsuits, disputes, and claims; and
the impact of changes in internal control over financial reporting.
Because these forward-looking statements involve risks and uncertainties, there are important factors that could cause our actual results to differ materially from those in the forward-looking statements. These factors include, without limitation, the following:
the risk that we or our franchisees will be unsuccessful in gauging apparel trends and changing consumer preferences;

 



the highly competitive nature of our business in the United States and internationally;
the risk that failure to maintain, enhance and protect our brand image could have an adverse effect on our results of operations;
the risk that the failure to attract and retain key personnel, or effectively manage succession, could have an adverse impact on our results of operations;
the risk that our investments in customer, digital, and omni-channel shopping initiatives may not deliver the results we anticipate;
the risk that if we are unable to manage our inventory effectively, our gross margins will be adversely affected;
the risk that we are subject to data or other security breaches that may result in increased costs, violations of law, significant legal and financial exposure, and a loss of confidence in our security measures, which could have an adverse effect on our results of operations and our reputation;
the risk that a failure of, or updates or changes to, our information technology (“IT”) systems may disrupt our operations;
the risk that trade matters could increase the cost or reduce the supply of apparel available to us and adversely affect our business, financial condition, and results of operations;
the risk that changes in the regulatory or administrative landscape could adversely affect our financial condition and results of operations;
the risks to our business, including our costs and supply chain, associated with global sourcing and manufacturing;
the risk that changes in global economic conditions or consumer spending patterns could adversely impact our results of operations;
the risks to our efforts to expand internationally, including our ability to operate in regions where we have less experience;
the risks to our reputation or operations associated with importing merchandise from foreign countries, including failure of our vendors to adhere to our Code of Vendor Conduct;
the risk that our franchisees’ operation of franchise stores is not directly within our control and could impair the value of our brands;
the risk that we or our franchisees will be unsuccessful in identifying, negotiating, and securing new store locations and renewing, modifying, or terminating leases for existing store locations effectively;
the risk that foreign currency exchange rate fluctuations could adversely impact our financial results;
the risk that comparable sales and margins will experience fluctuations;
the risk that changes in our credit profile or deterioration in market conditions may limit our access to the capital markets and adversely impact our financial results or our business initiatives;
the risk that natural disasters, public health crises, political crises, negative global climate patterns, or other catastrophic events could adversely affect our operations and financial results, or those of our franchisees or vendors;

 



the risk that reductions in income and cash flow from our credit card arrangement related to our private label and co-branded credit cards could adversely affect our operating results and cash flows;
the risk that the adoption of new accounting pronouncements will impact future results;
the risk that we do not repurchase some or all of the shares we anticipate purchasing pursuant to our repurchase program; and
the risk that we will not be successful in defending various proceedings, lawsuits, disputes, and claims.
Additional information regarding factors that could cause results to differ can be found in this Annual Report on Form 10-K and our other filings with the U.S. Securities and Exchange Commission (“SEC”).
Future economic and industry trends that could potentially impact net sales and profitability are difficult to predict. These forward-looking statements are based on information as of March 20, 2018, and we assume no obligation to publicly update or revise our forward-looking statements even if experience or future changes make it clear that any projected results expressed or implied therein will not be realized.

 



THE GAP, INC.
2017 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
 
 
Page
PART I
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 1B.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
PART II
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
Item 7.
 
 
 
Item 7A.
 
 
 
Item 8.
 
 
 
Item 9.
 
 
 
Item 9A.
 
 
 
Item 9B.
 
PART III
 
 
 
Item 10.
 
 
 
Item 11.
 
 
 
Item 12.
 
 
 
Item 13.
 
 
 
Item 14.
 
PART IV
 
 
 
Item 15.
 
 
 
Item 16.


 


Part I
Item 1. Business.
General
The Gap, Inc. (Gap Inc., the “Company,” “we,” and “our”) was incorporated in the State of California in July 1969 and was reincorporated under the laws of the State of Delaware in May 1988.
Gap Inc. is a leading global apparel retail company. We offer apparel, accessories, and personal care products for men, women, and children under the Old Navy, Gap, Banana Republic, Athleta, and Intermix brands. Our portfolio of distinct brands across multiple channels and geographies, combined with our size and scale which allows for strategic and advantageous partnerships with our third-party vendors and suppliers throughout the organization, gives us a competitive advantage in the global retail marketplace.
Gap Inc. is an omni-channel retailer, with sales to customers both in stores and online, through Company-operated and franchise stores, websites, and third-party arrangements. Gap Inc. has Company-operated stores in the United States, Canada, the United Kingdom, France, Ireland, Japan, Italy, China, Hong Kong, Taiwan, and Mexico. We also have franchise agreements with unaffiliated franchisees to operate Old Navy, Gap, and Banana Republic stores throughout Asia, Europe, Latin America, the Middle East, and Africa. Under these agreements, third parties operate stores that sell apparel and related products under our brand names. Most of the products sold under our brand names are designed by us and manufactured by independent sources. We also sell products that are designed and manufactured by branded third parties, primarily at our Intermix brand.
Gap Inc. is a leader among apparel retailers in using omni-channel capabilities to bridge the digital world and physical stores, creating world-class shopping experiences regardless of where or how our customers shop. The Company's suite of omni-channel services, including order-in-store, reserve-in-store, find-in-store, and ship-from-store, as well as enhanced mobile experiences, are uniquely tailored across its portfolio of brands.
Old Navy.  Old Navy is a global apparel and accessories brand that believes in the democracy of style, making high quality, must-have fashion essentials for the whole family, while delivering incredible value and fun, unique store experiences. Old Navy opened its first store in 1994 in the United States and since has expanded its international presence with Company-operated stores in Canada, China, and Mexico, as well as franchise stores in eight countries. Customers can purchase Old Navy products globally in Company-operated and franchise stores and online.
Gap.  Gap is one of the world's most iconic apparel and accessories brands anchored in optimistic, casual, American style. Founded in San Francisco in 1969, the brand's collections continue to build the foundation of modern wardrobes - all things denim, tees, button-downs, and khakis, along with must-have trends.
Gap is designed to build the foundation of modern wardrobes through every stage of life with apparel and accessories for adult men and women under the Gap name, in addition to GapKids, babyGap, GapMaternity, GapBody, and GapFit collections. Beginning in 1987 with the opening of the first store outside North America in London, Gap continues to connect with customers around the world through specialty stores, online, and franchise stores. In addition, we bring the brand to value-conscious customers, with exclusively designed collections for Gap Outlet and Gap Factory stores and websites.
Banana Republic.  Acquired with two stores in 1983 as a travel and adventure outfitter, Banana Republic is now a global apparel and accessories brand focused on delivering versatile, contemporary classics, designed for today with style that endures. Banana Republic offers clothing and accessories with detailed craftsmanship and luxurious materials. Customers can purchase Banana Republic products globally in our specialty stores, online, and franchise stores.

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Athleta.  Athleta is a premium fitness and lifestyle brand creating versatile performance apparel to inspire a community of active, confident women and girls. Established in 1998 and acquired by Gap Inc. in 2008, Athleta integrates technical features and innovative design across its women's collection to carry her through a life in motion, from yoga, training and sports, to everyday activities and travel. In 2016, the company launched Athleta Girl, mirroring its signature performance in styles for the next generation. Customers can purchase Athleta products in the United States through its stores and catalogs, or globally through its website.
Athleta has been certified as a benefit corporation ("B Corp"), furthering our commitment to using our business as a force for good to drive social and environmental impact. We have met rigorous standards across social and environmental performance, accountability and transparency. Additionally, we have amended Athleta's legal charter to become a Delaware Public Benefit Corporation in order to further uphold our commitments to people and the planet. With this accreditation, Gap Inc. has become one of the largest publicly traded retail companies with a B Corp certified subsidiary apparel brand. We plan to leverage the learnings from Athleta as a case study for Gap Inc., providing a benchmark and roadmap of potential opportunities for greater social and environmental impact across the enterprise.
Intermix. Intermix curates must-have styles from the most coveted emerging and established designers. Known for styling on-trend pieces in unexpected ways, Intermix delivers a unique point of view and an individualized approach to shopping and personal style. Customers can shop in stores in the United States and Canada, and online.
The range of merchandise displayed in each store varies depending on the selling season and the size and location of the store. Stores are generally open seven days per week (where permitted by law) and most holidays.
We ended fiscal 2017 with 3,165 Company-operated stores and 429 franchise store locations. For more information on the number of stores by brand and region, see the table in included in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, of this Form 10-K.
Old Navy, Gap, Banana Republic, and Athleta each have a private label credit card program and a co-branded credit card program through which frequent customers receive benefits. Private label and co-branded credit cards are provided by a third-party financing company, with associated revenue sharing arrangements reflected in Gap Inc. operations. We also issue and redeem gift cards through our brands.
Certain financial information about international operations is set forth under the heading "Segment Information" in Note 16 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Form 10-K.

Merchandise Vendors
We purchase private label and non-private label merchandise from about 800 vendors. Our vendors have factories in about 50 countries. Our two largest vendors each accounted for about 5 percent of the dollar amount of our total fiscal 2017 purchases. Of our merchandise purchased during fiscal 2017, substantially all purchases, by dollar value, were from factories outside the United States. Approximately 25 percent and 22 percent of our fiscal 2017 purchases, by dollar value, were from factories in Vietnam and China, respectively. Product cost increases or events causing disruption of imports from Vietnam, China, or other foreign countries, including the imposition of additional import restrictions or taxes, or vendors potentially failing due to political, financial, or regulatory issues, could have an adverse effect on our operations. Substantially all of our foreign purchases of merchandise are negotiated and paid for in U.S. dollars. Also see the sections entitled “Risk Factors—Our business is subject to risks associated with global sourcing and manufacturing," "Risk Factors—Risks associated with importing merchandise from foreign countries, including failure of our vendors to adhere to our Code of Vendor Conduct, could harm our business,” and “Risk Factors—Trade matters may disrupt our supply chain” in Item 1A, Risk Factors, of this Form 10-K.

Seasonal Business
Our business follows a seasonal pattern, with sales peaking during the end-of-year holiday period.

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Brand Building
Our ability to develop and evolve our existing brands is a key to our success. We believe our distinct brands are among our most important assets. With the exception of Intermix, virtually all aspects of brand development, from product design and distribution to marketing, merchandising and shopping environments, are controlled by Gap Inc. employees. With respect to Intermix, we control all aspects of brand development except for product design related to third-party products. We continue to invest in our business and enhance the customer experience through significant investments in our supply chain and customer, digital, and omni-channel capabilities, investments in marketing, enhancement of our online shopping sites, remodeling of existing stores, and international expansion.

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

Franchising
We have franchise agreements with unaffiliated franchisees to operate Old Navy, Gap, and Banana Republic stores in a number of countries throughout Asia, Europe, Latin America, the Middle East, and Africa. Under these agreements, third parties operate, or will operate, stores that sell apparel and related products under our brand names. For additional information on risks related to our franchise business, see the sections entitled “Risk Factors—Our efforts to expand internationally may not be successful” and “Risk Factors—Our franchise business is subject to certain risks not directly within our control that could impair the value of our brands” in Item 1A, Risk Factors, of this Form 10-K.

Inventory
The nature of the retail business requires us to carry a significant amount of inventory, especially prior to the peak holiday selling season when we, along with other retailers, generally build up inventory levels. We maintain a large part of our inventory in distribution centers. We review our inventory levels in order to identify slow-moving merchandise and broken assortments (items no longer in stock in a sufficient range of sizes or colors) and we primarily use promotions and markdowns to clear merchandise. Also see the sections entitled “Risk Factors—We must successfully gauge apparel trends and changing consumer preferences to succeed,” "Risk Factors—If we are unable to manage our inventory effectively, our gross margins could be adversely affected," and "Risk Factors—Our results could be adversely affected by natural disasters, public health crises, political crises, negative global climate patterns, or other catastrophic events" in Item 1A, Risk Factors, of this Form 10-K.

Competitors
The global apparel retail industry is highly competitive. We compete with local, national, and global apparel retailers. Also see the section entitled “Risk Factors—Our business is highly competitive” in Item 1A of this Form 10-K.

Employees
As of February 3, 2018, we had a workforce of approximately 135,000 employees, which includes a combination of part-time and full-time employees. We also hire seasonal employees, primarily during the peak holiday selling season.
To remain competitive in the retail apparel industry, we must attract, develop, and retain skilled employees in our design, merchandising, supply chain, marketing, and other functions, as well as in our stores and distribution centers. Competition for such personnel is intense. Our success is dependent to a significant degree on the continued contributions of key employees. Also see the section entitled “Risk Factors—The failure to attract and retain key personnel, or effectively manage succession, could have an adverse impact on our results of operations” in Item 1A, Risk Factors, of this Form 10-K.

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Available Information
We make available on our website, www.gapinc.com, under “Investors,” free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports as soon as reasonably practicable after we electronically file or furnish them to the SEC.
Our Board of Directors Committee Charters (Audit and Finance, Compensation and Management Development, and Governance and Sustainability Committees) and Corporate Governance Guidelines are also available on our website under “Investors, Governance.” Our Code of Business Conduct can be found on our website under “Investors, Corporate Compliance, Code of Business Conduct.” Any amendments and waivers to the Code will also be available on the website.

Executive Officers of the Registrant
The following are our executive officers:
Name, Age, Position, and Principal Occupation:
Arthur Peck, 62, Director, and President and Chief Executive Officer, Gap Inc. since February 2015; President, Growth, Innovation, and Digital division from 2012 to January 2015; President, Gap North America from 2011 to 2012; Executive Vice President of Strategy and Operations from 2005 to 2011; President, Gap Inc. Outlet from 2008 to 2011.
Mark Breitbard, 50, President and Chief Executive Officer, Banana Republic since May 2017; Chief Executive Officer, The Gymboree Corporation from January 2013 to April 2017; President, Gap North America from 2012 to January 2013; Executive Vice President, Gap North America Merchandising from 2011 to 2012; Executive Vice President, GapKids and babyGap from 2010 to 2011.
Paul Chapman, 60, Executive Vice President, Chief Information Officer since December 2015 (until April 2018); Senior Vice President and Chief Information Officer from January 2014 to December 2015; Senior Vice President, Information Technology, from 2010 to December 2015; Vice President, Information Technology from 2004 to 2010.
Shawn Curran, 54, Executive Vice President, Global Supply Chain and Product Operations since October 2017; Executive Vice President, Global Supply Chain - Logistics and Product Operations from April 2016 to October 2017; Executive Vice President, Global Supply Chain from August 2015 to April 2016; Senior Vice President, Logistics from 2012 to August 2015.
Sebastian DiGrande, 51, Executive Vice President, Strategy and Chief Customer Officer since May 2016; Senior Partner and Managing Director, the Boston Consulting Group from 1996 to April 2016.
Julie Gruber, 52, Executive Vice President, Global General Counsel, Corporate Secretary, and Chief Compliance Officer since February 2016; Senior Vice President and General Counsel from March 2015 to February 2016; Vice President and Deputy General Counsel from 2007 to March 2015; Associate General Counsel from 2003 to 2007.
Brent Hyder, 53, Executive Vice President and Chief People Officer since February 2018; Executive Vice President, Global Talent and Sustainability from May 2017 to February 2018; Executive Vice President and Chief Operating Officer, Gap from June 2016 to May 2017; Senior Vice President, Human Resources, Gap from September 2014 to June 2016; Vice President and General Manager, Gap Japan from February 2013 to September 2014; Vice President, Human Resources from May 2007 to February 2013.
Teri List-Stoll, 55, Executive Vice President and Chief Financial Officer since January 2017; Executive Vice President and Chief Financial Officer, Dick’s Sporting Goods, Inc. from August 2015 to September 2016; Executive Vice President and Chief Financial Officer, Kraft Foods Group, Inc. from September 2013 to May 2015; Senior Vice President and Treasurer, Procter & Gamble Co. from 2008 to August 2013.
Sonia Syngal, 48, President and Chief Executive Officer, Old Navy since April 2016; Executive Vice President, Global Supply Chain and Product Operations from February 2015 to April 2016; Executive Vice President, Global Supply Chain from November 2013 to January 2015; Senior Vice President, Old Navy International from February 2013 to November 2013; Senior Vice President and Managing Director, Europe from 2011 to February 2013; Senior Vice President and General Manager, International Outlets from 2010 to 2011; Vice President of Global Production, Supply Chain - Outlet from 2006 to 2010.

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Item 1A. Risk Factors.
Our past performance may not be a reliable indicator of future performance because actual future results and trends may differ materially depending on a variety of factors, including but not limited to the risks and uncertainties discussed below. In addition, historical trends should not be used to anticipate results or trends in future periods.

We must successfully gauge apparel trends and changing consumer preferences to succeed.
Our success is largely dependent upon our ability to gauge the tastes of our customers and to provide merchandise that satisfies customer demand in a timely manner. However, lead times for many of our design and purchasing decisions may make it more difficult for us to respond rapidly to new or changing apparel trends or consumer acceptance of our products. The global apparel retail business fluctuates according to changes in consumer preferences, dictated in part by apparel trends and season. To the extent we misjudge the market for our merchandise or the products suitable for local markets or fail to execute trends and deliver product to market as timely as our competitors, our sales will be adversely affected, and the markdowns required to move the resulting excess inventory will adversely affect our operating results.

Our business is highly competitive.
The global apparel retail industry is highly competitive. We and our franchisees compete with local, national, and global department stores, specialty and discount store chains, independent retail stores, and online businesses that market similar lines of merchandise. We face a variety of competitive challenges in an increasingly complex and fast-paced environment, including:
anticipating and quickly responding to changing apparel trends and customer demands;
attracting customer traffic both in stores and online;
competitively pricing our products and achieving customer perception of value;
maintaining favorable brand recognition and effectively marketing our products to customers in several diverse market segments and geographic locations;
anticipating and responding to changing customer shopping preferences and practices, including the increasing shift to digital brand engagement, social media communication, and online shopping;
developing innovative, high-quality products in sizes, colors, and styles that appeal to customers of varying age groups and tastes;
purchasing and stocking merchandise to match seasonal weather patterns, and our ability to react to shifts in weather that impact consumer demand;
sourcing and allocating merchandise efficiently; and
improving the effectiveness and efficiency of our processes in order to deliver cost savings to fund growth.
If we or our franchisees are not able to compete successfully in the United States or internationally, our results of operations would be adversely affected.

We must maintain our reputation and brand image.
Our brands have wide recognition, and our success has been due in large part to our ability to maintain, enhance and protect our brand image and reputation and our customers’ connection to our brands. Our continued success depends in part on our ability to adapt to a rapidly changing media environment, including our increasing reliance on social media and online dissemination of advertising campaigns. Even if we react appropriately to negative posts or comments about us and/or our brands on social media and online, our customers’ perception of our brand image and our reputation could be negatively impacted. In addition, customer sentiment could be shaped by our sustainability policies and related design, sourcing and operations decisions. Failure to maintain, enhance and protect our brand image could have a material adverse effect on our results of operations.

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The failure to attract and retain key personnel, or effectively manage succession, could have an adverse impact on our results of operations.
Our ability to anticipate and effectively respond to changing apparel trends depends in part on our ability to attract and retain key personnel in our design, merchandising, sourcing, marketing, and other functions. In addition, several of our strategic initiatives, including our technology initiatives and supply chain initiatives, require that we hire and/or develop employees with appropriate experience. Competition for talent is intense, and we cannot be sure that we will be able to attract and retain a sufficient number of qualified personnel in future periods. If we are unable to retain, attract, and motivate talented employees with the appropriate skill sets, or if changes to our organizational structure, operating results, or business model adversely affect morale or retention, we may not achieve our objectives and our results of operations could be adversely impacted. In addition, the loss of one or more of our key personnel or the inability to effectively identify a suitable successor to a key role could have a material adverse effect on our business. In fiscal 2017, there were changes to our senior leadership team, including our new President and Chief Executive Officer of Banana Republic, and our new Executive Vice President and Chief People Officer. In addition, in February 2018, we announced the departure of our President and Chief Executive Officer of Gap brand. The effectiveness of new leaders in these roles, and any further transition as a result of these changes, could have a significant impact on our results of operations.

Our investments in customer, digital, and omni-channel shopping initiatives may not deliver the results we anticipate.
One of our strategic priorities is to further develop an omni-channel shopping experience for our customers through the integration of our store and digital shopping channels. Our omni-channel initiatives include cross-channel logistics optimization and exploring additional ways to develop an omni-channel shopping experience, including further digital integration and customer personalization. These initiatives involve significant investments in IT systems and significant operational changes. In addition, our competitors are also investing in omni-channel initiatives, some of which may be more successful than our initiatives. If the implementation of our customer, digital, and omni-channel initiatives is not successful, or we do not realize the return on our investments in these initiatives that we anticipate, our operating results would be adversely affected.

If we are unable to manage our inventory effectively, our gross margins could be adversely affected.
Fluctuations in the global apparel retail markets impact the levels of inventory owned by apparel retailers. The nature of the global apparel retail business requires us to carry a significant amount of inventory, especially prior to the peak holiday selling season when we build up our inventory levels. Merchandise usually must be ordered well in advance of the season and frequently before apparel trends are confirmed by customer purchases. We must enter into contracts for the purchase and manufacture of merchandise well in advance of the applicable selling season. As a result, we are vulnerable to demand and pricing shifts and to suboptimal selection and timing of merchandise purchases. In the past, we have not always predicted our customers’ preferences and acceptance levels of our trend items with accuracy. If sales do not meet expectations, too much inventory may cause excessive markdowns and, therefore, lower-than-planned margins.
We have key strategic initiatives designed to optimize our inventory levels and increase the efficiency and responsiveness of our supply chain, including vendor fabric platforming, product demand testing, and in-season rapid response to demand. These initiatives involve significant systems and operational changes, and we have limited experience operating in this manner. If we are unable to implement these initiatives successfully, we may not realize the return on our investments that we anticipate, and our operating results could be adversely affected.

6



We are subject to data and security risks, which could have an adverse effect on our results of operations and consumer confidence in our security measures.
As part of our normal operations, we receive and maintain confidential, proprietary, and personally identifiable information, including credit card information, and information about our customers, our employees, job applicants, and other third parties. Our business employs systems and websites that allow for the secure storage and transmission of this information. However, despite our safeguards and security processes and protections, security breaches could expose us to a risk of loss or misuse of this information, litigation, and potential liability. The retail industry, in particular, has been the target of many recent cyber-attacks. We may not have the resources to anticipate or prevent rapidly evolving types of cyber-attacks. Attacks may be targeted at us, our vendors or customers, or others who have entrusted us with information. In addition, even if we take appropriate measures to safeguard our information security and privacy environment from security breaches, we could still expose our customers and our business to risk. Actual or anticipated attacks may disrupt or impair our technology capabilities, and may cause us to incur increasing costs, including costs to deploy additional personnel and protection technologies, train employees, and engage third-party experts and consultants. Advances in computer capabilities, new technological discoveries, or other developments may result in the technology used by us to protect transaction or other data being breached or compromised. Measures we implement to protect against cyber attacks may also have the potential to impact our customers’ shopping experience or decrease activity on our websites by making them more difficult to use. Data and security breaches can also occur as a result of non-technical issues, including intentional or inadvertent breach by our employees or by persons with whom we have commercial relationships that result in the unauthorized release of personal or confidential information. In addition, the global regulatory environment surrounding information security, cybersecurity, and privacy is increasingly demanding, with new and changing requirements, such as the European Union's General Protection Regulation (GDPR), and customers have a high expectation that the Company will adequately protect their personal information from cyber-attack or other security breaches. Security breaches and cyber incidents could result in a violation of applicable privacy and other laws, significant legal and financial exposure, and a loss of consumer confidence in our security measures, which could have an adverse effect on our results of operations and our reputation.

Failures of, updates or changes to, our IT systems may disrupt operations.
We maintain a complex network of legacy systems. We require continual maintenance, upgrades and changes, some of which are significant. Upgrades involve replacing existing systems with successor systems, making changes to existing systems, or cost-effectively acquiring new systems with new functionality. We are aware of inherent risks associated with maintaining and replacing these systems, including accurately capturing data and addressing system disruptions and believe we are taking appropriate action to mitigate the risks through testing, training, and staging implementation, as well as ensuring appropriate commercial contracts are in place with third-party vendors supplying or supporting our IT initiatives. However, there can be no assurances that we will successfully maintain or launch these systems as planned or that they will be implemented without disruptions to our operations. IT system disruptions or failures, if not anticipated and appropriately mitigated, or failure to successfully implement new or upgraded systems, could have a material adverse effect on our results of operations.


7


Trade matters may disrupt our supply chain.
Trade restrictions, including increased tariffs or quotas, embargoes, safeguards, and customs restrictions against apparel items, as well as U.S. or foreign labor strikes, work stoppages, or boycotts, could increase the cost or reduce the supply of apparel available to us and adversely affect our business, financial condition, and results of operations. We cannot predict whether any of the countries in which our merchandise currently is manufactured or may be manufactured in the future will be subject to additional trade restrictions imposed by the United States or other foreign governments, including the likelihood, type, or effect of any such restrictions. For example, the current political landscape has introduced greater uncertainty with respect to future tax and trade regulations. In addition, we face the possibility of anti-dumping or countervailing duties lawsuits from U.S. domestic producers. We are unable to determine the impact of the changes to the quota system or the impact that potential tariff lawsuits could have on our global sourcing operations. Our sourcing operations may be adversely affected by trade limits or political and financial instability, resulting in the disruption of trade from exporting countries, significant fluctuation in the value of the U.S. dollar against foreign currencies, restrictions on the transfer of funds, and/or other trade disruptions. Changes in tax policy or trade regulations, such as the imposition of new tariffs on imported products, could have a material adverse effect on our business and results of operations.

Changes in the regulatory or administrative landscape could adversely affect our financial condition and results of operations.
Laws and regulations at the local, state, federal, and international levels frequently change, and the ultimate cost of compliance cannot be precisely estimated. In addition, we cannot predict the impact that may result from changes in the regulatory or administrative landscape.
Any changes in laws or regulations, the imposition of additional laws or regulations, or the enactment of any new or more stringent legislation that impacts employment and labor, trade, product safety, transportation and logistics, health care, tax, privacy, operations, or environmental issues, among others, could have an adverse impact on our financial condition and results of operations.

Our business is subject to risks associated with global sourcing and manufacturing.
Independent third parties manufacture all of our products for us. As a result, we are directly impacted by increases in the cost of those products.
If we experience significant increases in demand or need to replace an existing vendor, there can be no assurance that additional manufacturing capacity will be available when required on terms that are acceptable to us or that any vendor would allocate sufficient capacity to us in order to meet our requirements. In addition, for any new manufacturing source, we may encounter delays in production and added costs as a result of the time it takes to train our vendors in our methods, products, quality control standards, and environmental, labor, health, and safety standards. Moreover, in the event of a significant disruption in the supply of the fabrics or raw materials used by our vendors in the manufacture of our products, our vendors might not be able to locate alternative suppliers of materials of comparable quality at an acceptable price. Any delays, interruption, or increased costs in the manufacture of our products could result in lower sales and net income. In addition, certain countries represent a larger portion of our global sourcing. For example, approximately 25 percent and 22 percent of our merchandise, by dollar value, is purchased from factories in Vietnam and China, respectively. Accordingly, any delays in production and added costs in Vietnam or China could have a more significant impact on our results of operations.
Because independent vendors manufacture virtually all of our products outside of our principal sales markets, third parties must transport our products over large geographic distances. Delays in the shipment or delivery of our products due to the availability of transportation, work stoppages, port strikes, infrastructure congestion, or other factors, and costs and delays associated with transitioning between vendors, could adversely impact our financial performance. Operating or manufacturing delays, transportation delays, or unexpected demand for our products may require us to use faster, but more expensive, transportation methods such as aircraft, which could adversely affect our gross margins. In addition, the cost of fuel is a significant component of transportation costs, so increases in the price of petroleum products can adversely affect our gross margins.


8


Global economic conditions and any related impact on consumer spending patterns could adversely impact our results of operations.
The Company’s performance is subject to global economic conditions, as well as their impact on levels of consumer spending worldwide. Some of the factors that may influence consumer spending include high levels of unemployment, higher consumer debt levels, reductions in net worth based on market declines and uncertainty, home foreclosures and reductions in home values, fluctuating interest and foreign currency rates and credit availability, government austerity measures, fluctuating fuel and other energy costs, fluctuating commodity prices, and general uncertainty regarding the overall future economic environment. Consumer purchases of discretionary items, including our merchandise, generally decline during periods when disposable income is adversely affected or there is economic uncertainty.
Adverse economic changes in any of the regions in which we and our franchisees sell our products could reduce consumer confidence, and thereby could negatively affect earnings and have a material adverse effect on our results of operations. In challenging and uncertain economic environments, we cannot predict whether or when such circumstances may improve or worsen, or what impact, if any, such circumstances could have on our business, results of operations, cash flows, and financial position.

Our efforts to expand internationally may not be successful.
Our current strategies include pursuing selective international expansion in a number of countries around the world through a number of channels. This includes our franchisees opening additional stores internationally. We have limited experience operating or franchising in some of these locations. In many of these locations, we face major, established competitors. In addition, in many of these locations, the real estate, employment and labor, transportation and logistics, regulatory, and other operating requirements differ dramatically from those in the places where we have more experience. Consumer tastes and trends may differ in many of these locations and, as a result, the sales of our products may not be successful or result in the margins we anticipate. If our international expansion plans are unsuccessful or do not deliver an appropriate return on our investments, our operations and financial results could be materially, adversely affected.

Risks associated with importing merchandise from foreign countries, including failure of our vendors to adhere to our Code of Vendor Conduct, could harm our business.
We purchase nearly all merchandise from third-party vendors in many different countries, and we require those vendors to adhere to a Code of Vendor Conduct, which includes environmental, labor, health, and safety standards. From time to time, contractors or their subcontractors may not be in compliance with these standards or applicable local laws. Although we have implemented policies and procedures to facilitate our compliance with laws and regulations relating to doing business in foreign markets and importing merchandise into various countries, there can be no assurance that suppliers and other third parties with whom we do business will not violate such laws and regulations or our policies. Significant or continuing noncompliance with such standards and laws by one or more vendors could have a negative impact on our reputation, could subject us to liability, and could have an adverse effect on our results of operations.

9



Our franchise business is subject to certain risks not directly within our control that could impair the value of our brands.
We enter into franchise agreements with unaffiliated franchisees to operate stores and, in limited circumstances, websites, in many countries around the world. Under these agreements, third parties operate, or will operate, stores and websites that sell apparel and related products under our brand names. The effect of these arrangements on our business and results of operations is uncertain and will depend upon various factors, including the demand for our products in new markets internationally and our ability to successfully identify appropriate third parties to act as franchisees, distributors, or in a similar capacity. In addition, certain aspects of these arrangements are not directly within our control, such as franchisee financial stability and the ability of these third parties to meet their projections regarding store locations, store openings, and sales. Other risks that may affect these third parties include general economic conditions in specific countries or markets, foreign exchange rates, changes in diplomatic and trade relationships, restrictions on the transfer of funds, and political instability. Moreover, while the agreements we have entered into and plan to enter into in the future provide us with certain termination rights, the value of our brands could be impaired to the extent that these third parties do not operate their stores in a manner consistent with our requirements regarding our brand identities and customer experience standards. Failure to protect the value of our brands, or any other harmful acts or omissions by a franchisee, could have an adverse effect on our results of operations and our reputation.

The market for prime real estate is competitive.
Our ability to effectively obtain real estate - to open new stores, distribution centers, and corporate offices nationally and internationally - depends on the availability of real estate that meets our criteria for traffic, square footage, co-tenancies, lease economics, demographics, and other factors. We also must be able to effectively renew our existing store leases. In addition, we may seek to downsize, consolidate, reposition, relocate, or close some of our real estate locations, which in most cases requires a modification of an existing store lease. Failure to secure adequate new locations, successfully modify or exit existing locations, or failure to effectively manage the profitability of our existing fleet of stores, could have a material adverse effect on our results of operations.
Additionally, the economic environment may at times make it difficult to determine the fair market rent of real estate properties within the United States and internationally. This could impact the quality of our decisions to exercise lease options at previously negotiated rents and the quality of our decisions to renew expiring leases at negotiated rents. Any adverse effect on the quality of these decisions could impact our ability to retain real estate locations adequate to meet our targets or efficiently manage the profitability of our existing fleet of stores and could have a material adverse effect on our financial condition or results of operations.

Our business is exposed to the risks of foreign currency exchange rate fluctuations and our hedging strategies may not be effective in mitigating those risks.
We are exposed to foreign currency exchange rate risk with respect to our sales, operating expenses, profits, assets, and liabilities generated or incurred in foreign currencies as well as inventory purchases in U.S. dollars for our foreign subsidiaries. Although we use financial instruments to hedge certain foreign currency risks, these measures may not succeed in fully offsetting the negative impact of foreign currency rate movements and generally only delay the impact of adverse foreign currency rate movements on our business and financial results.


10


We experience fluctuations in our comparable sales and margins.
Our success depends in part on our ability to improve sales, in particular at our largest brands. A variety of factors affect comparable sales or margins, including but not limited to apparel trends, competition, current economic conditions, the timing of new merchandise releases and promotional events, changes in our merchandise mix, the success of marketing programs, foreign currency fluctuations, industry traffic trends, and weather conditions. These factors may cause our comparable sales results and margins to differ materially from prior periods and from expectations. Our comparable sales, including the associated comparable online sales, have fluctuated significantly in the past on an annual and quarterly basis. Over the past fiscal year, our reported quarterly comparable sales have ranged from a high of positive 5 percent in the fourth quarter of fiscal 2017 to a low of positive 1 percent in the second quarter of fiscal 2017. Over the past five years, our reported gross margins have ranged from a high of 39.0 percent in fiscal 2013 to a low of 36.2 percent in fiscal 2015. In addition, over the past five years, our reported operating margins have ranged from a high of 13.3 percent in fiscal 2013 to a low of 7.7 percent in fiscal 2016.
Our ability to deliver strong comparable sales results and margins depends in large part on accurately forecasting demand and apparel trends, selecting effective marketing techniques, providing an appropriate mix of merchandise for our broad and diverse customer base, managing inventory effectively, using effective pricing strategies, and optimizing store performance. Failure to meet the expectations of investors, securities analysts, or credit rating agencies in one or more future periods could reduce the market price of our common stock, cause our credit ratings to decline, and impact liquidity.

Changes in our credit profile or deterioration in market conditions may limit our access to the capital markets and adversely impact our financial position or our business initiatives.
In April 2011, we issued $1.25 billion aggregate principal amount of 5.95 percent notes due April 2021. As a result, we have additional costs that include interest payable semi-annually on the notes. In January 2014, we also entered into a 15 billion Japanese yen, four-year, unsecured term loan which was fully repaid in June 2017.
Our cash flows from operations are the primary source of funds for these debt service payments. In this regard, we have generated annual cash flow from operating activities in excess of $1 billion per year for well over a decade and ended fiscal 2017 with $1.8 billion of cash and cash equivalents on our balance sheet. We are also able to supplement near-term liquidity, if necessary, with our $500 million revolving credit facility. We continue to target a cash balance between $1.0 billion to $1.2 billion, which provides not only for our working capital needs, but also a reserve for unexpected business downturns. However, if our cash flows from operating activities decline significantly, we may be required to reprioritize our business initiatives to ensure that we can continue to service or refinance our debt with favorable rates and terms. In addition, any future reduction in our long-term senior unsecured credit ratings could result in reduced access to the credit and capital markets and higher interest costs and potentially increased lease or hedging costs.

In May 2016, Fitch Ratings and Standard & Poor's Rating Services downgraded their respective credit ratings of us from BBB- negative outlook to BB+ stable outlook. These downgrades, and any future reduction in our long-term senior unsecured credit ratings, could result in reduced access to the credit and capital markets, more restrictive covenants in future financial documents and higher interest costs, and potentially increased lease or hedging costs.
For further information on our debt and credit facilities, see Item 8, Financial Statements and Supplementary Data, Notes 4 and 5 of Notes to Consolidated Financial Statements of this Form 10-K.


11


Our results could be adversely affected by natural disasters, public health crises, political crises, negative global climate patterns, or other catastrophic events.
Natural disasters, such as hurricanes, tornadoes, floods, earthquakes, and other adverse weather conditions; unforeseen public health crises, such as pandemics and epidemics; political crises, such as terrorist attacks, war, labor unrest, and other political instability; negative global climate patterns, especially in water stressed regions; or other catastrophic events, such as fires or other disasters occurring at our distribution centers or our vendors' manufacturing facilities, whether occurring in the United States or internationally, could disrupt our operations, including the operations of our franchisees, or the operations of one or more of our vendors. In particular, these types of events could impact our supply chain from or to the impacted region and could impact our ability or the ability of our franchisees or other third parties to operate our stores or websites. In addition, these types of events could negatively impact consumer spending in the impacted regions or, depending upon the severity, globally. Disasters occurring at our vendors manufacturing facilities could impact our reputation and our customers perception of our brands. To the extent any of these events occur, our operations and financial results could be adversely affected.

Reductions in income and cash flow from our credit card arrangement related to our private label and co-branded credit cards could adversely affect our operating results and cash flows.
A third-party, Synchrony Financial (“Synchrony”), owns and services our private label credit card and co-branded programs. Our agreement with Synchrony provides for certain payments to be made by Synchrony to us, including a share of revenues from the performance of the credit card portfolios. The income and cash flow that we receive from Synchrony is dependent upon a number of factors, including the level of sales on private label and co-branded accounts, the level of balances carried on the accounts, payment rates on the accounts, finance charge rates and other fees on the accounts, the level of credit losses for the accounts, Synchrony’s ability to extend credit to our customers as well as the cost of customer rewards programs. All of these factors can vary based on changes in federal and state credit card, banking, and commercial protection laws. The factors affecting the income and cash flow that the Company receives from Synchrony can also vary based on a variety of economic, legal, social, and other factors that we cannot control. If the income and cash flow that we receive from our consumer credit card program agreement with Synchrony decreases significantly, our operating results and cash flows could be adversely affected.

We are subject to various proceedings, lawsuits, disputes, and claims from time to time, which could adversely affect our business, financial condition, and results of operations.
As a multinational company, we are subject to various proceedings, lawsuits, disputes, and claims (“Actions”) arising in the ordinary course of our business. Many of these Actions raise complex factual and legal issues and are subject to uncertainties. Actions filed against us from time to time include commercial, intellectual property, customer, employment, and data privacy claims, including class action lawsuits. The plaintiffs in some Actions seek unspecified damages or injunctive relief, or both. Actions are in various procedural stages and some are covered in part by insurance. We cannot predict with assurance the outcome of Actions brought against us. Accordingly, developments, settlements, or resolutions may occur and impact income in the quarter of such development, settlement, or resolution. An unfavorable outcome could have an adverse impact on our business, financial condition and results of operations.
Item 1B. Unresolved Staff Comments.
None.
Item 2. Properties.
We have Company-operated stores in the United States, Canada, the United Kingdom, France, Ireland, Japan, Italy, China, Hong Kong, Taiwan, and Mexico. As of February 3, 2018, we had 3,165 Company-operated stores, which aggregated to approximately 36.4 million square feet. Almost all of these stores are leased, typically with one or more renewal options after our initial term. Terms vary by type and location of store.

12


We own approximately 1.1 million square feet of corporate office space located in San Francisco, San Bruno, Pleasanton, and Rocklin, California, of which approximately 184,000 square feet is leased to and occupied by others. We lease approximately 1.0 million square feet of corporate office space located in San Francisco, Rocklin, Petaluma, and Pleasanton, California; New York and Brooklyn, New York; Albuquerque, New Mexico; and Toronto, Ontario, Canada. Of the 1.0 million square feet of leased corporate office space, approximately 40,000 square feet is subleased to and occupied by others. We also lease regional offices in North America and in various international locations. We own approximately 8.9 million square feet of distribution space located in Fresno, California; Fishkill, New York; Groveport, Ohio; Gallatin, Tennessee; Brampton, Ontario, Canada; and Rugby, England. Of the 8.9 million square feet of owned distribution space, approximately 117,000 square feet is leased to and occupied by others. We lease approximately 765,000 square feet of distribution space located in Phoenix, Arizona; Erlanger and Hebron, Kentucky; and Bolton, Ontario, Canada. Third-party logistics companies provide logistics services to us through distribution warehouses in Chiba, Japan; and Shanghai and Hong Kong, China.
Item 3. Legal Proceedings.
We do not believe that the outcome of any current Action would have a material effect on our Consolidated Financial Statements.
Item 4. Mine Safety Disclosures.
Not applicable.

13


Part II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
The principal market on which our stock is traded is the New York Stock Exchange. The number of holders of record of our stock as of March 14, 2018 was 6,336. The table below sets forth the market prices and dividends declared and paid for each of the fiscal quarters in fiscal 2017 and 2016.
 
 
Market Prices
 
Dividends Declared
and Paid
 
 
Fiscal 2017
 
Fiscal 2016
 
Fiscal Year
 
 
High
 
Low
 
High
 
Low
 
2017
 
2016
1st Quarter
 
$
26.72

 
$
22.03

 
$
30.49

 
$
22.03

 
$
0.23

 
$
0.23

2nd Quarter
 
$
26.88

 
$
21.02

 
$
25.95

 
$
17.00

 
0.23

 
0.23

3rd Quarter
 
$
29.77

 
$
21.84

 
$
27.34

 
$
21.57

 
0.23

 
0.23

4th Quarter
 
$
35.68

 
$
25.36

 
$
30.74

 
$
22.25

 
0.23

 
0.23

 
 
 
 
 
 
 
 
 
 
$
0.92

 
$
0.92



14


Stock Performance Graph
The graph below compares the percentage changes in our cumulative total stockholder return on our common stock for the five-year period ended February 3, 2018, with (i) the S&P 500 Index and (ii) the cumulative total return of the Dow Jones U.S. Retail Apparel Index. The total stockholder return for our common stock assumes quarterly reinvestment of dividends.
TOTAL RETURN TO STOCKHOLDERS
(Assumes $100 investment on 2/2/2013)
chart-a1dd9284658059c689ba11.jpg
Total Return Analysis
 
 
2/2/2013
 
2/1/2014
 
1/31/2015
 
1/30/2016
 
1/28/2017
 
2/3/2018
The Gap, Inc.
 
$
100.00

 
$
117.60

 
$
129.93

 
$
80.21

 
$
76.19

 
$
112.10

S&P 500
 
$
100.00

 
$
121.52

 
$
138.80

 
$
137.88

 
$
165.51

 
$
209.22

Dow Jones U.S. Apparel Retailers
 
$
100.00

 
$
113.71

 
$
137.70

 
$
135.94

 
$
133.98

 
$
152.50

Source: Research Data Group, Inc. (415) 643-6000 (www.researchdatagroup.com)


15


Purchases of Equity Securities by the Issuer and Affiliated Purchasers
The following table presents information with respect to purchases of common stock of the Company made during the fourteen weeks ended February 3, 2018 by The Gap, Inc. or any affiliated purchaser, as defined in Exchange Act Rule 10b-18(a)(3):
 
 
Total Number
of Shares
Purchased (1)
 
Average
Price Paid
Per Share
Including
Commissions
 
Total Number
of Shares
Purchased as
Part of Publicly
Announced
Plans or
Programs
 
Maximum Number
(or approximate
dollar amount) of
Shares that May
Yet be Purchased
Under the Plans or
Programs (2)
Month #1 (October 29 - November 25)
 
336,891

 
$
29.68

 
336,891

 
$690 million
Month #2 (November 26 - December 30)
 
164,915

 
$
30.32

 
164,915

 
$685 million
Month #3 (December 31 - February 3)
 

 
$

 

 
$685 million
Total
 
501,806

 
$
29.89

 
501,806

 
 
__________
(1)
Excludes shares withheld to settle employee statutory tax withholding related to the vesting of stock units.
(2)
On February 25, 2016, we announced that the Board of Directors approved a $1 billion share repurchase authorization (the "February 2016 repurchase program"), which has no expiration date.

16


Item 6. Selected Financial Data.
The following selected financial data are derived from the Consolidated Financial Statements of the Company. We have also included certain non-financial data to enhance your understanding of our business. The data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 and the Company’s Consolidated Financial Statements and related notes in Item 8 of this Form 10-K.
 
 
Fiscal Year (number of weeks)
 
 
2017 (53) (b)
 
2016 (52)
 
2015 (52)
 
2014 (52)
 
2013 (52)
Operating Results ($ in millions)
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
15,855

 
$
15,516

 
$
15,797

 
$
16,435

 
$
16,148

Gross margin
 
38.3
 %
 
36.3
 %
 
36.2
 %
 
38.3
%
 
39.0
%
Operating margin
 
9.3
 %
 
7.7
 %
 
9.6
 %
 
12.7
%
 
13.3
%
Net income
 
$
848

 
$
676

 
$
920

 
$
1,262

 
$
1,280

Cash dividends paid
 
$
361

 
$
367

 
$
377

 
$
383

 
$
321

Per Share Data (number of shares in millions)
 
 
 
 
 
 
 
 
 
 
Basic earnings per share
 
$
2.16

 
$
1.69

 
$
2.24

 
$
2.90

 
$
2.78

Diluted earnings per share
 
$
2.14

 
$
1.69

 
$
2.23

 
$
2.87

 
$
2.74

Weighted-average number of shares—basic
 
393

 
399

 
411

 
435

 
461

Weighted-average number of shares—diluted
 
396

 
400

 
413

 
440

 
467

Cash dividends declared and paid per share
 
$
0.92

 
$
0.92

 
$
0.92

 
$
0.88

 
$
0.70

Balance Sheet Information ($ in millions)
 
 
 
 
 
 
 
 
 
 
Merchandise inventory
 
$
1,997

 
$
1,830

 
$
1,873

 
$
1,889

 
$
1,928

Total assets
 
$
7,989

 
$
7,610

 
$
7,473

 
$
7,690

 
$
7,849

Working capital (a)
 
$
2,107

 
$
1,862

 
$
1,450

 
$
2,083

 
$
1,985

Total long-term debt, less current maturities
 
$
1,249

 
$
1,248

 
$
1,310

 
$
1,332

 
$
1,369

Stockholders’ equity
 
$
3,144

 
$
2,904

 
$
2,545

 
$
2,983

 
$
3,062

Other Data ($ and square footage in millions)
 
 
 
 
 
 
 
 
 
 
Cash used for purchases of property and equipment
 
$
731

 
$
524

 
$
726

 
$
714

 
$
670

Percentage increase (decrease) in comparable sales
 
3
 %
 
(2
)%
 
(4
)%
 
%
 
2
%
Number of Company-operated store locations open at year-end
 
3,165

 
3,200

 
3,275

 
3,280

 
3,164

Number of franchise store locations open at year-end
 
429

 
459

 
446

 
429

 
375

Number of total store locations open at year-end
 
3,594

 
3,659

 
3,721

 
3,709

 
3,539

Square footage of Company-operated store space at year-end
 
36.4

 
36.7

 
37.9

 
38.1

 
37.2

Percentage increase (decrease) in square footage of Company-operated store space at year-end
 
(0.8
)%
 
(3.2
)%
 
(0.5
)%
 
2.4
%
 
0.8
%
Number of employees at year-end
 
135,000

 
135,000

 
141,000

 
141,000

 
137,000


17


__________
(a)
In fiscal year 2015, we adopted the Financial Accounting Standards Board, Accounting Standard Update No. 2015-17, Income Taxes. The adoption reduced the current portion of deferred tax assets as a result of classifying all net deferred tax assets as noncurrent as of January 30, 2016 on a prospective basis.
(b)
In fiscal year 2017, the company recognized a net provisional tax impact of approximately $34 million, which represents the provisional tax impact of federal tax reform of $57 million, net of a related $23 million benefit related to legal entity structuring that was also impacted by tax reform. Fiscal 2017 results also include incremental sales attributable to the 53rd week.


18


Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Overview
We are a global retailer offering apparel, accessories, and personal care products for men, women, and children under the Old Navy, Gap, Banana Republic, Athleta, and Intermix brands. We have Company-operated stores in the United States, Canada, the United Kingdom, France, Ireland, Japan, Italy, China, Hong Kong, Taiwan, and Mexico. We have franchise agreements with unaffiliated franchisees to operate Old Navy, Gap, and Banana Republic stores throughout Asia, Europe, Latin America, the Middle East, and Africa. Under these agreements, third parties operate, or will operate, stores that sell apparel and related products under our brand names. Our products are also available to customers online through Company-owned websites and through the use of third parties that provide logistics and fulfillment services. In addition to operating in the specialty, outlet, online, and franchise channels, we also use our omni-channel capabilities to bridge the digital world and physical stores to further enhance our shopping experience for our customers. Our omni-channel services, including order-in-store, reserve-in-store, find-in-store, and ship-from-store, as well as enhanced mobile experiences, are tailored uniquely across our portfolio of brands. Most of the products sold under our brand names are designed by us and manufactured by independent sources. We also sell products that are designed and manufactured by branded third parties, primarily at our Intermix brand.
We identify our operating segments according to how our business activities are managed and evaluated. As of February 3, 2018, our operating segments included Gap Global, Old Navy Global, Banana Republic Global, Athleta, and Intermix. We have determined that each of our operating segments share similar economic and other qualitative characteristics, and therefore the results of our operating segments are aggregated into one reportable segment.
Fiscal 2017 consisted of 53 weeks versus 52 weeks in fiscal 2016 and 2015. Net sales and operating results, as well as other metrics derived from the Consolidated Statement of Income, include the impact of the additional week; however, the comparable sales calculation excludes the 53rd week.
On August 29, 2016, a fire occurred in one of the buildings at a Company-owned distribution center campus in Fishkill, New York ("the Fishkill fire"). In January 2018, the Company agreed upon a final settlement with its insurers and all insurance proceeds were received as of February 3, 2018.
In May 2016, we announced measures to better align talent and financial resources against our most important priorities to position the Company for improved business performance and long-term success. Our aim is to capture additional market share in our home market, North America, where we have our largest structural advantages, and to focus on international regions with the greatest potential. As part of this effort, we closed the entire fleet of 53 Old Navy stores in Japan during fiscal 2016. Japan remains an important market for the Company's portfolio, with a continued strong presence of approximately 200 Gap and Banana Republic stores. Including the Old Navy closures in Japan, the Company closed 67 stores in total related to these measures in fiscal 2016.
We also took steps toward creating a more efficient operating model, enabling us to more fully leverage our scale. For example, we centralized or consolidated several brand and corporate functions, allowing us to simplify the organization and operate more efficiently.
In connection with the decision to close stores and streamline the Company's operations, the Company incurred $197 million in restructuring costs during fiscal 2016 on a pre-tax basis. The charges primarily include lease termination fees, employee-related costs, and store asset impairment. Certain of the costs incurred in foreign subsidiaries did not result in a tax benefit.

19


Fiscal 2015 results were impacted by a series of strategic actions to position Gap brand for improved business performance in the future, including rightsizing the Gap brand store fleet primarily in North America, streamlining the brand's headquarter workforce, and developing a clear, on-brand product aesthetic framework to strengthen the Gap brand to compete more successfully on the global stage. During fiscal 2015, the Company completed the closure of about 150 Gap global specialty stores related to the strategic actions. During fiscal 2015, the Company incurred $132 million of charges in connection with the strategic actions, primarily consisting of impairment of store assets related to underperforming stores, lease termination fees and lease losses, employee-related expenses, and impairment of inventory that did not meet brand standards.
Financial results for fiscal 2017 are as follows:
Net sales for fiscal 2017 increased 2 percent to $15.9 billion compared with $15.5 billion for fiscal 2016.
Comparable sales for fiscal 2017 increased 3 percent.
Gross profit for fiscal 2017 was $6.1 billion compared with $5.6 billion for fiscal 2016. Gross margin for fiscal 2017 was 38.3 percent compared with 36.3 percent for fiscal 2016.
Operating margin for fiscal 2017 was 9.3 percent compared with 7.7 percent for fiscal 2016. Operating margin is defined as operating income as a percentage of net sales.
Net income for fiscal 2017 was $848 million compared with $676 million for fiscal 2016, and diluted earnings per share was $2.14 for fiscal 2017 compared with $1.69 for fiscal 2016. Diluted earnings per share for fiscal 2017 included about a $0.10 benefit from the gain from insurance proceeds related to the Fishkill fire and an unfavorable net provisional tax impact of federal tax reform of about $0.09. Diluted earnings per share for fiscal 2016 included about a $0.41 impact of restructuring costs incurred during fiscal 2016, a non-cash goodwill impairment charge of $0.18 related to Intermix, an $0.11 benefit from the gain from insurance proceeds related to the Fishkill fire, and a favorable income tax impact of a legal structure realignment of about $0.15.
During fiscal 2017, we distributed $676 million to shareholders through share repurchases and dividends.
Our business priorities in 2018 include:
offering product that is consistently brand-appropriate and on-trend with high customer acceptance, with a focus on expanding our advantage in loyalty categories;
investing in digital and customer capabilities to support growth;
creating a unique and differentiated shopping experience that attracts new customers and builds loyalty, with focus on both the physical and digital expressions of our brands;
increasing productivity by leveraging our scale and streamlining operations and processes throughout the organization;
continuing to integrate social and environmental sustainability into business practices to support long term growth; and
attracting and retaining strong talent in our businesses and functions.
In fiscal 2018, we are focused on investing strategically in the business while maintaining operating expense discipline and driving efficiency through our productivity initiative. One of our primary objectives is to continue transforming our product to market process, with the development of a more efficient operating model, allowing us to more fully leverage our scale. To enable this, we have several product, supply chain, and IT initiatives underway. Further, we expect to continue our investment in customer experience to drive higher customer engagement and loyalty across all of our brands and channels, resulting in market share gains. Finally, we will continue to invest in strengthening brand awareness, customer acquisition, and digital capabilities. Underpinning these strategies is a focus on utilizing data, analytics, and technology to respond faster while making decisions that will fuel market share gains and lead to a more nimble organization.
Fiscal 2018 will consist of 52 weeks versus 53 weeks in fiscal 2017.

20


Results of Operations
Net Sales
See Item 8, Financial Statements and Supplementary Data, Note 16 of Notes to Consolidated Financial Statements for net sales by brand and region.

Comparable Sales ("Comp Sales")
The percentage change in Comp Sales by global brand and for total Company, as compared with the preceding year, is as follows:
 
 
Fiscal Year
 
 
2017
 
2016
 
2015
Gap Global
 
(1
)%
 
(3
)%
 
(6
)%
Old Navy Global
 
6
 %
 
1
 %
 
 %
Banana Republic Global
 
(2
)%
 
(7
)%
 
(10
)%
The Gap, Inc.
 
3
 %
 
(2
)%
 
(4
)%
Comp Sales include the results of Company-operated stores and sales through online channels in those countries where we have existing comparable store sales. The calculation of The Gap, Inc. Comp Sales includes the results of Athleta and Intermix but excludes the results of our franchise business.
A store is included in the Comp Sales calculations when it has been open and operated by the Company for at least one year and the selling square footage has not changed by 15 percent or more within the past year. A store is included in the Comp Sales calculations on the first day it has comparable prior year sales. Stores in which the selling square footage has changed by 15 percent or more as a result of a remodel, expansion, or reduction are excluded from the Comp Sales calculations until the first day they have comparable prior year sales.
A store is considered non-comparable (“Non-comp”) when it has been open and operated by the Company for less than one year or has changed its selling square footage by 15 percent or more within the past year.
A store is considered “Closed” if it is temporarily closed for three or more full consecutive days or it is permanently closed. When a temporarily closed store reopens, the store will be placed in the Comp/Non-comp status it was in prior to its closure. If a store was in Closed status for three or more days in the prior year, the store will be in Non-comp status for the same days the following year.
Current year foreign exchange rates are applied to both current year and prior year Comp Sales to achieve a consistent basis for comparison.

Store Count and Square Footage Information
Net sales per average square foot is as follows:
 
 
Fiscal Year
 
 
2017 (2)
 
2016
 
2015
Net sales per average square foot (1)
 
$
340

 
$
334

 
$
337

__________
(1)
Excludes net sales associated with our online and franchise businesses. Online sales includes both sales through our online channels as well as ship-from-store sales.
(2)
Fiscal 2017 includes incremental sales attributable to the 53rd week.

21


Store count, openings, closings, and square footage for our stores are as follows:
 
 
January 28, 2017
 
Fiscal 2017
 
February 3, 2018
 
 
Number of
Store Locations
 
Number of
Stores Opened
 
Number of
Stores Closed
 
Number of
Store Locations
 
Square Footage
(in millions)
Gap North America
 
844

 
8

 
42

 
810

 
8.4

Gap Asia
 
311

 
52

 
50

 
313

 
3.0

Gap Europe
 
164

 
3

 
12

 
155

 
1.3

Old Navy North America
 
1,043

 
32

 
9

 
1,066

 
17.7

Old Navy Asia
 
13

 
1

 

 
14

 
0.2

Banana Republic North America
 
601

 
5

 
30

 
576

 
4.9

Banana Republic Asia
 
48

 
1

 
4

 
45

 
0.2

Banana Republic Europe
 
1

 

 
1

 

 

Athleta North America
 
132

 
16

 

 
148

 
0.6

Intermix North America
 
43

 

 
5

 
38

 
0.1

Company-operated stores total
 
3,200

 
118

 
153

 
3,165

 
36.4

Franchise
 
459

 
34

 
64

 
429

 
N/A

Total
 
3,659

 
152

 
217

 
3,594

 
36.4

Decrease over prior year
 
 
 
 
 
 
 
(1.8
)%
 
(0.8
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
January 30, 2016
 
Fiscal 2016
 
January 28, 2017
 
 
Number of
Store Locations
 
Number of
Stores Opened
 
Number of
Stores Closed
 
Number of
Store Locations
 
Square Footage
(in millions)
Gap North America
 
866

 
14

 
36

 
844

 
8.8

Gap Asia
 
305

 
27

 
21

 
311

 
3.0

Gap Europe
 
175

 
2

 
13

 
164

 
1.4

Old Navy North America
 
1,030

 
27

 
14

 
1,043

 
17.4

Old Navy Asia
 
65

 
5

 
57

 
13

 
0.2

Banana Republic North America
 
612

 
9

 
20

 
601

 
5.0

Banana Republic Asia
 
51

 

 
3

 
48

 
0.2

Banana Republic Europe
 
10

 

 
9

 
1

 

Athleta North America
 
120

 
12

 

 
132

 
0.6

Intermix North America
 
41

 
3

 
1

 
43

 
0.1

Company-operated stores total
 
3,275

 
99

 
174

 
3,200

 
36.7

Franchise
 
446

 
56

 
43

 
459

 
N/A

Total
 
3,721

 
155

 
217

 
3,659

 
36.7

Decrease over prior year
 
 
 
 
 
 
 
(1.7
)%
 
(3.2
)%
Gap and Banana Republic outlet and factory stores are reflected in each of the respective brands.
In fiscal 2018, we expect net openings of about 25 Company-operated store locations, primarily for Old Navy and Athleta, with closures weighted toward Gap brand and Banana Republic.



22


Net Sales Discussion
Our net sales for fiscal 2017 increased $339 million, or 2 percent, compared with fiscal 2016, primarily due to an increase in net sales at Old Navy and Athleta, partially offset by a decrease in net sales at Gap and Banana Republic. The translation of net sales in foreign currencies to U.S. dollars had an unfavorable impact of about $11 million for fiscal 2017 and is calculated by translating net sales for fiscal 2016 at exchange rates applicable during fiscal 2017. Fiscal 2017 includes incremental sales attributable to the 53rd week.
Our net sales for fiscal 2016 decreased $281 million, or 2 percent, compared with fiscal 2015 primarily due to a decrease in net sales at Gap and Banana Republic, partially offset by an increase in net sales at Old Navy and Athleta. The translation of net sales in foreign currencies to U.S. dollars had an unfavorable impact of about $20 million for fiscal 2016 and is calculated by translating net sales for fiscal 2015 at exchange rates applicable during fiscal 2016.
In fiscal 2018, we will return to a 52-week fiscal year which could potentially impact the seasonality of net sales throughout the year as a result of the calendar shift of our fiscal quarters in fiscal 2018 compared with fiscal 2017.

Cost of Goods Sold and Occupancy Expenses
($ in millions)
 
Fiscal Year
2017
 
2016
 
2015
Cost of goods sold and occupancy expenses
 
$
9,789

 
$
9,876

 
$
10,077

Gross profit
 
$
6,066

 
$
5,640

 
$
5,720

Cost of goods sold and occupancy expenses as a percentage of net sales
 
61.7
%
 
63.7
%
 
63.8
%
Gross margin
 
38.3
%
 
36.3
%
 
36.2
%
Cost of goods sold and occupancy expenses decreased 2.0 percentage points as a percentage of net sales in fiscal 2017 compared with fiscal 2016.
Cost of goods sold decreased 1.3 percentage points as a percentage of net sales in fiscal 2017 compared with fiscal 2016, primarily driven by higher margins achieved as a result of improved average selling price per unit at all global brands; partially offset by higher average unit cost at all global brands. This was offset by a negative foreign exchange impact for our foreign subsidiaries as our merchandise purchases are primarily in U.S. dollars.
Occupancy expenses decreased 0.7 percentage points as a percentage of net sales in fiscal 2017 compared with fiscal 2016, primarily driven by an increase in online sales without a corresponding increase in occupancy expenses, international store closures, and higher sales from the impact of the 53rd week; partially offset by real estate expenses for the Times Square New York location for Gap and Old Navy.
Cost of goods sold and occupancy expenses decreased 0.1 percentage points as a percentage of net sales in fiscal 2016 compared with fiscal 2015.
Cost of goods sold decreased 0.3 percentage points as a percentage of net sales in fiscal 2016 compared with fiscal 2015, primarily driven by higher selling at regular prices at all global brands and improved product acceptance resulting in improved margins at Old Navy. This was offset by a negative foreign exchange impact for our foreign subsidiaries as our merchandise purchases are primarily in U.S. dollars.
Occupancy expenses increased 0.2 percentage points as a percentage of net sales in fiscal 2016 compared with fiscal 2015, primarily driven by the decrease in net sales without a corresponding decrease in occupancy expenses.
In fiscal 2018, we currently expect that gross margins for our foreign subsidiaries, net of the impact from our merchandise hedge program, will be slightly favorable due to the appreciation of certain foreign currencies as our merchandise purchases are primarily in U.S. dollars.

23


Operating Expenses and Operating Margin
($ in millions)
 
Fiscal Year
 
2017
 
2016
 
2015
Operating expenses
 
$
4,587

 
$
4,449

 
$
4,196

Operating expenses as a percentage of net sales
 
28.9
%
 
28.7
%
 
26.6
%
Operating margin
 
9.3
%
 
7.7
%
 
9.6
%
Operating expenses increased $138 million or 0.2 percentage points as a percentage of net sales in fiscal 2017 compared with fiscal 2016 primarily due to the following:
an increase in variable costs, such as payroll-related costs, due to the growth in Old Navy and Athleta brands, increase in bonus expense, and the 53rd week impact;
an increase in advertising; and
an increase in overhead costs related to productivity work including investments in customer and digital initiatives as well as severance expenses and the impacts of store closures; partially offset by
a gain from insurance proceeds of $64 million related to the Fishkill fire recorded in the second quarter of fiscal year 2017;
a decrease of $197 million of restructuring costs incurred in fiscal year 2016; and
a decrease of $71 million related to a goodwill impairment charges for Intermix in fiscal year 2016.
Operating expenses increased $253 million or 2.1 percentage points as a percentage of net sales in fiscal 2016 compared with fiscal 2015 primarily due to the following:
restructuring costs of $197 million in fiscal 2016 compared with the costs related to strategic actions of $98 million in fiscal 2015;
store asset impairment charges of $53 million unrelated to restructuring activities in fiscal 2016 compared with store asset impairment charges of $16 million unrelated to the strategic actions in fiscal 2015;
a goodwill impairment charge related to Intermix in fiscal 2016 of $71 million; and
an increase in bonus and marketing expense; partially offset by
a gain from insurance proceeds of $73 million related to the Fishkill fire, representing the excess over the loss on inventory; and
higher income from revenue sharing payments from Synchrony.

Interest Expense
($ in millions)
 
Fiscal Year
2017
 
2016
 
2015
Interest expense
 
$
74

 
$
75

 
$
59

Interest expense for fiscal 2017 and 2016 primarily includes interest on overall borrowings and obligations mainly related to our $1.25 billion long-term debt.
Interest expense for fiscal 2015 includes $74 million of interest on overall borrowings and obligations mainly related to our $1.25 billion long-term debt, offset by a reversal of $15 million of interest expense primarily resulting from a favorable foreign tax ruling and actions of foreign tax authorities related to transfer pricing matters in fiscal 2015.

24



Income Taxes
($ in millions)
 
Fiscal Year
2017
 
2016
 
2015
Income taxes
 
$
576

 
$
448

 
$
551

Effective tax rate
 
40.4
%
 
39.9
%
 
37.5
%
On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (“TCJA”) was enacted into law, which significantly changes existing U.S. tax law and includes numerous provisions that affect our business, such as imposing a one-time transition tax on deemed repatriation of deferred foreign income, reducing the U.S. federal statutory tax rate, and adopting a territorial tax system. The TCJA resulted in a one-time transition tax, payable over eight years without interest or penalties, on deferred foreign income not previously subject to U.S. income tax at a rate of 15.5% for income held in foreign cash and certain other net current assets, and 8% on the remaining income. The TCJA also reduces the U.S. federal statutory tax rate from 35% to 21% effective January 1, 2018, which resulted in a remeasurement of deferred tax assets and liabilities.
We have calculated a reasonable estimate of the impact of the TCJA in our income tax provision in accordance with our understanding of guidance available as of the date of this filing and as a result have recorded $57 million as additional income tax expense in the fourth quarter of fiscal 2017, the period in which the legislation was enacted.
The increase in the effective tax rate for fiscal 2017 compared with fiscal 2016 was primarily due to the impact of the TCJA, partially offset by the recognition of certain tax benefits associated with legal structure changes.
The increase in the effective tax rate for fiscal 2016 compared with fiscal 2015 was primarily due to the impact of restructuring costs incurred in certain foreign subsidiaries for which the Company was not able to recognize any tax benefit and the impact of a non-deductible goodwill impairment charge related to Intermix. The increase was partially offset by the recognition of certain foreign tax benefits associated with a legal structure realignment.
Liquidity and Capital Resources
Our largest source of cash flows is cash collections from the sale of our merchandise. Our primary uses of cash include merchandise inventory purchases, occupancy costs, personnel-related expenses, purchases of property and equipment, and payment of taxes. In addition, we may have dividend payments, debt repayments, and share repurchases.
We consider the following to be measures of our liquidity and capital resources:
($ in millions)
 
February 3,
2018
 
January 28,
2017
 
January 30,
2016
Cash and cash equivalents
 
$
1,783

 
$
1,783

 
$
1,370

Debt
 
$
1,249

 
$
1,313

 
$
1,731

Working capital
 
$
2,107

 
$
1,862

 
$
1,450

Current ratio
 
1.86:1

 
1.76:1

 
1.57:1

As of February 3, 2018, the majority of our cash and cash equivalents was held in the United States and is generally accessible without any limitations.
In October 2015, the Company entered into a $400 million unsecured term loan (the "Term Loan"), which was fully repaid in January 2017.
In January 2014, the Company entered into a 15 billion Japanese yen, four-year, unsecured term loan ("Japan Term Loan"), which was fully repaid in June 2017.

25


We believe that current cash balances and cash flows from our operations will be sufficient to support our business operations, including growth initiatives, planned capital expenditures, and repayment of debt, for the next 12 months and beyond. We are also able to supplement near-term liquidity, if necessary, with our $500 million revolving credit facility or other available market instruments.

Cash Flows from Operating Activities
Net cash provided by operating activities during fiscal 2017 decreased $339 million compared with fiscal 2016, primarily due to the following:
Net income
an increase of $172 million in net income.
Non-cash items
a decrease of $79 million in store asset impairment charges in fiscal 2017 compared with fiscal 2016 in part due to restructuring activities in fiscal 2016; and
a decrease of $71 million due to a goodwill impairment charge related to Intermix during fiscal 2016.
Changes in operating assets and liabilities
a decrease of $236 million related to accounts payable primarily due to timing of payments;
a decrease of $188 million related to merchandise inventory primarily due to the volume and timing of receipts; and
a decrease of $71 million related to income taxes payable, net of prepaid and other tax-related items, primarily due to the timing of tax payments, partially offset by an increase in estimated current expense in fiscal 2017 compared with fiscal 2016; partially offset by
an increase of $115 million related to the recognition of deferred tax expense in fiscal 2017 compared with deferred tax benefit in fiscal 2016 primarily due to the deferred tax impact of federal tax reform and favorable current year temporary differences.
Net cash provided by operating activities during fiscal 2016 increased $125 million compared with fiscal 2015, primarily due to the following:
Net income
a decrease of $244 million in net income.
Non-cash items
an increase of $246 million related to non-cash and other items primarily due to the lower gain reclassified into income related to our derivative financial instruments in fiscal 2016 compared with fiscal 2015, a goodwill impairment charge related to Intermix of $71 million during fiscal 2016, and an increase of $53 million related to store asset impairment; partially offset by
a decrease of $155 million related to deferred income taxes driven by fluctuations in book versus tax temporary differences for bonus accruals, depreciation, and share-based compensation.
Changes in operating assets and liabilities
an increase of $193 million related to accounts payable primarily due to the timing of merchandise and lease payments;
an increase of $117 million related to accrued expenses and other current liabilities primarily due to bonus accruals; and
an increase of $52 million related to merchandise inventory primarily due to the volume and timing of receipts; partially offset by
a decrease of $79 million related to other current assets and other long-term assets in part due to the insurance claim receivable from the Fishkill fire.
We fund inventory expenditures during normal and peak periods through cash flows from operating activities and available cash. Our business follows a seasonal pattern, with sales peaking during the end-of-year holiday period. The seasonality of our operations, combined with the calendar shift of weeks in fiscal 2018 compared with fiscal 2017 as a result of the 53rd week in fiscal 2017, may lead to significant fluctuations in certain asset and liability accounts between fiscal year-end and subsequent interim periods.


26


Cash Flows from Investing Activities
Net cash used for investing activities during fiscal 2017 increased $139 million compared with fiscal 2016, primarily due to the following:
$207 million increase for purchases of property and equipment in fiscal 2017 compared with fiscal 2016 primarily related to the rebuilding of the Company's Fishkill, New York distribution center campus; partially offset by
$66 million related to insurance proceeds allocated to loss on property and equipment in fiscal 2017 primarily related to the Fishkill fire compared with no insurance proceeds allocated to loss on property and equipment in fiscal 2016.
Net cash used for investing activities during fiscal 2016 decreased $201 million compared with fiscal 2015, primarily due to less property and equipment purchases.
In fiscal 2017, cash used for purchases of property and equipment was $731 million primarily related to investments in stores, information technology, and supply chain, including costs associated with the rebuilding of the company's Fishkill, New York distribution center campus.

Cash Flows from Financing Activities
Net cash used for financing activities during fiscal 2017 decreased $46 million compared with fiscal 2016, primarily due to the following:
$67 million related to the final repayment of the Japan term loan in full in June 2017 compared with a $421 million payment of debt in fiscal 2016; partially offset by
$315 million of cash used for repurchases of common stock in fiscal 2017 compared with no repurchases of common stock in fiscal 2016.
Net cash used for financing activities during fiscal 2016 decreased $213 million compared with fiscal 2015, primarily due to the following:
no repurchases of common stock in fiscal 2016 compared with $1 billion cash outflow related to repurchases of common stock in fiscal 2015; partially offset by
no debt issuances in fiscal 2016 compared with the issuance of $400 million in debt in fiscal 2015; and
the repayment of $400 million in debt in fiscal 2016.

Free Cash Flow
Free cash flow is a non-GAAP financial measure. We believe free cash flow is an important metric because it represents a measure of how much cash a company has available for discretionary and non-discretionary items after the deduction of capital expenditures as we require regular capital expenditures to build and maintain stores and purchase new equipment to improve our business. We use this metric internally, as we believe our sustained ability to generate free cash flow is an important driver of value creation. However, this non-GAAP financial measure is not intended to supersede or replace our GAAP result. Free cash flow for fiscal 2017 is further adjusted for insurance proceeds allocated to loss on property and equipment, as our cash used for purchases of property and equipment for fiscal 2017 includes certain capital expenditures related to the rebuilding of the Company-owned distribution center which was impacted by the Fishkill fire.
The following table reconciles free cash flow, a non-GAAP financial measure, from net cash provided by operating activities, a GAAP financial measure.
 
 
Fiscal Year
($ in millions)
 
2017
 
2016
 
2015
Net cash provided by operating activities
 
$
1,380

 
$
1,719

 
$
1,594

Less: Purchases of property and equipment
 
(731
)
 
(524
)
 
(726
)
Add: Insurance proceeds related to loss on property and equipment
 
66

 

 

Free cash flow
 
$
715

 
$
1,195

 
$
868


Debt and Credit Facilities
Certain financial information about the Company's debt and credit facilities is set forth under the headings "Debt" and "Credit Facilities" in Notes 4 and 5, respectively, of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Form 10-K.

27



Dividend Policy
In determining whether and at what level to declare a dividend, we consider a number of factors including sustainability, operating performance, liquidity, and market conditions.
We paid an annual dividend of $0.92 per share in fiscal 2017 and fiscal 2016. We intend to increase our annual dividend to $0.97 per share in fiscal 2018.

Share Repurchases
Certain financial information about the Company's share repurchases is set forth under the heading "Share Repurchases" in Note 8 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Form 10-K.
Contractual Cash Obligations
We are party to many contractual obligations involving commitments to make payments to third parties. The following table provides summary information concerning our future contractual obligations as of February 3, 2018. These obligations impact our short-term and long-term liquidity and capital resource needs. Certain of these contractual obligations are reflected in the Consolidated Balance Sheet as of February 3, 2018, while others are disclosed as future obligations.
 
 
Payments Due by Period
($ in millions)
 
Less than 1
Year
 
1-3 Years
 
3-5 Years
 
More Than 5
Years
 
Total
Debt (1)
 
$

 
$

 
$
1,250

 
$

 
$
1,250

Interest payments on debt
 
74

 
149

 
37

 

 
260

Operating leases (2)
 
1,162

 
2,128

 
1,390

 
1,792

 
6,472

Purchase obligations and commitments (3)
 
3,891

 
84

 
26

 
40

 
4,041

Total contractual cash obligations
 
$
5,127

 
$
2,361

 
$
2,703

 
$
1,832

 
$
12,023

__________
(1)
Represents principal maturities, excluding interest. See Note 4 of Notes to Consolidated Financial Statements for discussion on debt.
(2)
Excludes maintenance, insurance, taxes, and contingent rent obligations. See Note 11 of Notes to Consolidated Financial Statements for discussion of our operating leases.
(3)
Represents estimated open purchase orders to purchase inventory as well as commitments for products and services used in the normal course of business.
There is $138 million of long-term liabilities recorded in lease incentives and other long-term liabilities in the Consolidated Balance Sheet as of February 3, 2018 that is excluded from the table above as the amount relates to uncertain tax positions and deferred compensation, and we are not able to reasonably estimate the timing of the payments or the amount by which the liability will increase or decrease over time.

Commercial Commitments
We have commercial commitments, not reflected in the table above, that were incurred in the normal course of business to support our operations, including standby letters of credit of $15 million, surety bonds of $43 million, and bank guarantees of $22 million outstanding (of which $17 million was issued under the unsecured revolving credit facilities for our operations in foreign locations) as of February 3, 2018.

Other Cash Obligations Not Reflected in the Consolidated Balance Sheet (Off-Balance Sheet Arrangements)
The majority of our contractual obligations relate to operating leases for our stores. Future minimum lease payments represent commitments under non-cancelable operating leases and are disclosed in the table above with additional information provided under the heading "Leases" in Note 11 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Form 10-K.

28


Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") requires management to adopt accounting policies and make significant judgments and estimates to develop amounts reflected and disclosed in the financial statements. In many cases, there are alternative policies or estimation techniques that could be used. We maintain a thorough process to review the application of our accounting policies and to evaluate the appropriateness of the many estimates that are required to prepare the financial statements of a large, global corporation. However, even under optimal circumstances, estimates routinely require adjustment based on changing circumstances and the receipt of new or better information.
Our significant accounting policies can be found under the heading "Organization and Summary of Significant Accounting Policies" in Note 1 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Form 10-K. The policies and estimates discussed below include the financial statement elements that are either judgmental or involve the selection or application of alternative accounting policies and are material to our financial statements. Management has discussed the development and selection of these critical accounting policies and estimates with the Audit and Finance Committee of our Board of Directors, which has reviewed our disclosure relating to critical accounting policies and estimates in this annual report on Form 10-K.

Merchandise Inventory
We value inventory at the lower of cost or net realizable value (“LCNRV”), with cost determined using the weighted-average cost method. We review our inventory levels in order to identify slow-moving merchandise and broken assortments (items no longer in stock in a sufficient range of sizes or colors), and we primarily use promotions and markdowns to clear merchandise. We record an adjustment to inventory when future estimated selling price is less than cost. Our LCNRV adjustment calculation requires management to make assumptions to estimate the selling price and amount of slow-moving merchandise and broken assortments subject to markdowns, which is dependent upon factors such as historical trends with similar merchandise, inventory aging, forecasted consumer demand, and the promotional environment. In addition, we estimate and accrue shortage for the period between the last physical count and the balance sheet date. Our shortage estimate can be affected by changes in merchandise mix and changes in actual shortage trends. Historically, actual shortage has not differed materially from our estimates.
We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate our LCNRV or inventory shortage adjustments. However, if estimates regarding consumer demand are inaccurate or actual physical inventory shortage differs significantly from our estimate, our operating results could be affected. We have not made any material changes in the accounting methodology used to calculate our LCNRV or inventory shortage adjustments in the past three fiscal years.


29


Impairment of Long-Lived Assets, Goodwill, and Intangible Assets
We review the carrying amount of long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Events that result in an impairment review include a significant decrease in the operating performance of the long-lived asset, or the decision to close a store, corporate facility, or distribution center. Long-lived assets are considered impaired if the carrying amount exceeds the estimated undiscounted future cash flows of the asset or asset group. For impaired assets, we recognize a loss equal to the difference between the carrying amount of the asset or asset group and its estimated fair value. The estimated fair value of the asset or asset group is based on estimated discounted future cash flows of the asset or asset group using a discount rate commensurate with the related risk. The asset group is defined as the lowest level for which identifiable cash flows are available and largely independent of the cash flows of other groups of assets. The asset group for our retail stores is reviewed for impairment primarily at the store level. Our estimate of future cash flows requires management to make assumptions and to apply judgment, including forecasting future sales and expenses and estimating useful lives of the assets. These estimates can be affected by factors such as future store results, real estate demand, and economic conditions that can be difficult to predict. We have not made any material changes in the methodology to assess and calculate impairment of long-lived assets in the past three fiscal years. We recorded a charge for the impairment of long-lived assets of $28 million, $107 million, and $54 million for fiscal 2017, 2016, and 2015, respectively, related to store assets, which is recorded in operating expenses in the Consolidated Statements of Income.
We also review the carrying amount of goodwill and other indefinite-lived intangible assets for impairment annually in the fourth quarter of the fiscal year and whenever events or changes in circumstances indicate that it is more likely than not that the carrying amount may not be recoverable. Events that result in an impairment review include significant changes in the business climate, declines in our operating results, or an expectation that the carrying amount may not be recoverable.
We early adopted ASU No. 2017-04, Intangibles - Goodwill and Other: Simplifying the Test for Goodwill Impairment in the first quarter of fiscal 2017. The amendments simplify the subsequent measurement of goodwill impairment by eliminating the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge. Under the ASU, the impairment test is simply the comparison of the fair value of a reporting unit with its carrying amount, with the impairment charge being the deficit in fair value but not exceeding the total amount of goodwill allocated to that reporting unit. The simplified one-step impairment test applies to all reporting units (including those with zero or negative carrying amounts).
In connection with the acquisitions of Athleta in September 2008 and Intermix in December 2012, we recorded $99 million and $81 million of goodwill. Goodwill is reviewed for impairment using the applicable reporting unit, which is an operating segment or a business unit one level below that operating segment for which discrete financial information is prepared and regularly reviewed by segment management. We have deemed Athleta and Intermix to be the reporting units at which goodwill is tested for Athleta and Intermix, respectively. During the fourth quarter of fiscal 2017, we completed our annual impairment testing of goodwill and we did not recognize any impairment charges. We determined that the respective fair value of goodwill attributed to Athleta and Intermix significantly exceeded their respective carrying amount as of the date of our annual impairment review.

30


In fiscal 2016, the Company performed the goodwill impairment test under the previous FASB Accounting Standards Codification No. 350 Intangibles - Goodwill and Other as the annual impairment test was performed prior to January 1, 2017. At the end of each of the first three quarters of fiscal 2016, given the information available at the time of those assessments, we determined that there were no events or circumstances that indicated any impairment for goodwill related to Intermix. During the fourth quarter of fiscal 2016, management updated the fiscal 2017 budget and financial projections beyond fiscal 2017 for Intermix. There were several factors that caused the financial projections and estimates to significantly decrease from the previous estimates, which included: poor fourth quarter of fiscal 2016 holiday performance at Intermix stores, the decision to reduce expected future store openings, the approval of additional store closures in fiscal 2017, and the budgeting of additional headcount required to support increased focus on the online business. These factors arising during the fourth quarter of fiscal 2016 had a significant and negative impact on the estimated fair value of the Intermix reporting unit, and we determined that the Intermix reporting unit’s carrying value exceeded its fair value as of the date of our annual impairment review. As such, we performed the second step of the goodwill impairment test which resulted in an impairment charge of $71 million for goodwill related to Intermix in fiscal 2016. This impairment charge reduced the $81 million of purchase price allocated to goodwill in connection with the acquisition of Intermix in December 2012 to $10 million as of January 28, 2017.
We did not recognize any impairment charges for goodwill in fiscal 2015.
As of February 3, 2018, the aggregate carrying value of trade names was $95 million, which primarily consisted of $54 million and $38 million related to Athleta and Intermix, respectively. A trade name is considered impaired if the carrying amount exceeds its estimated fair value. If a trade name is considered impaired, we recognize a loss equal to the difference between the carrying amount and the estimated fair value of the trade name. The fair value of the trade names is determined using the relief from royalty method. During the fourth quarter of fiscal 2017, we completed our annual impairment review of the trade names, and we did not recognize any impairment charges.
These analyses require management to make assumptions and to apply judgment, including forecasting future sales and expenses, and selecting appropriate discount rates and royalty rates, which can be affected by economic conditions and other factors that can be difficult to predict.
If actual store and online results and brand performance, real estate market conditions, and economic conditions including interest rates are not consistent with our estimates and assumptions used in our calculations, we may be exposed to additional impairment losses that could be material.

Revenue Recognition
While revenue recognition for the Company does not involve significant judgment, it represents an important accounting policy. We recognize revenue and the related cost of goods sold at the time the products are received by the customers. For sales transacted at stores, revenue is recognized when the customer receives and pays for the merchandise at the register. For sales where we ship the merchandise to the customer from a distribution center or store, revenue is recognized at the time we estimate the customer receives the merchandise.
We sell merchandise to franchisees under multi-year franchise agreements. We recognize revenue from sales to franchisees at the time merchandise ownership is transferred to the franchisee, which generally occurs when the merchandise reaches the franchisee’s predesignated turnover point. We also receive royalties from franchisees primarily based on a percentage of the total merchandise purchased by the franchisee, net of any refunds or credits due them. Royalty revenue is recognized primarily when merchandise ownership is transferred to the franchisee.
We record an allowance for estimated returns based on our historical return patterns and various other assumptions that management believes to be reasonable. We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate our sales return allowance. However, if the actual rate of sales returns increases significantly, our operating results could be adversely affected. We have not made any material changes in the accounting methodology used to estimate future sales returns in the past three fiscal years.

31


See Note 1 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Form 10-K for recent accounting pronouncements related to revenue recognition and expected impact from the adoption of new standards.

Unredeemed Gift Cards, Gift Certificates, and Credit Vouchers
Upon issuance of a gift card, gift certificate, or credit voucher, a liability is established for its cash value. The liability is relieved and net sales are recorded upon redemption by the customer. Over time, some portion of these instruments is not redeemed (“breakage”). Based on historical redemption patterns, we determine breakage income for gift cards, gift certificates, and credit vouchers when we can determine the portion of the liability where redemption is remote, which is three years after issuance. Breakage income, which has been historically immaterial, is recorded in other income which is a component of operating expenses in the Consolidated Statements of Income. When breakage income is recorded, a liability is recognized for any legal obligation to remit the unredeemed portion to relevant jurisdictions. Substantially all of our gift cards, gift certificates, and credit vouchers have no expiration dates.
We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate our breakage income. However, if the actual pattern of redemption for gift cards, gift certificates, and credit vouchers changes significantly, our operating results could be adversely affected. We have not made any material changes in the accounting methodology used to estimate breakage in the past three fiscal years. See Note 1 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Form 10-K for recent accounting pronouncements related to revenue recognition and expected impact on recognition of breakage income from the adoption of new standards.

Income Taxes
We record a valuation allowance against our deferred tax assets when it is more likely than not that some portion or all of such deferred tax assets will not be realized. In determining the need for a valuation allowance, management is required to make assumptions and to apply judgment, including forecasting future income, taxable income, and the mix of income or losses in the jurisdictions in which we operate. Our effective tax rate in a given financial statement period may also be materially impacted by changes in the mix and level of income or losses, changes in the expected outcome of audits, or changes in the deferred tax valuation allowance.
At any point in time, many tax years are subject to or in the process of being audited by various taxing authorities. To the extent our estimates of settlements change or the final tax outcome of these matters is different from the amounts recorded, such differences will impact the income tax provision in the period in which such determinations are made. Our income tax expense includes changes in our estimated liability for exposures associated with our various tax filing positions. Determining the income tax expense for these potential assessments requires management to make assumptions that are subject to factors such as proposed assessments by tax authorities, changes in facts and circumstances, issuance of new regulations, and resolution of tax audits.
We believe the judgments and estimates discussed above are reasonable. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to losses or gains that could be material.
See Note 12 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Form 10-K for the impact of the U.S. Tax Cuts and Jobs Act enacted on December 22, 2017 on income taxes.
Recent Accounting Pronouncements
See "Organization and Summary of Significant Accounting Policies" in Note 1 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Form 10-K for recent accounting pronouncements, including the expected dates of adoption and estimated effects on our Consolidated Financial Statements.

32


Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Derivative Financial Instruments
Certain financial information about the Company's derivative financial instruments is set forth under the heading "Derivative Financial Instruments" in Note 7 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Form 10-K.
We have performed a sensitivity analysis as of February 3, 2018 based on a model that measures the impact of a hypothetical 10 percent adverse change in foreign currency exchange rates to U.S. dollars (with all other variables held constant) on our underlying estimated major foreign currency exposures, net of derivative financial instruments. The foreign currency exchange rates used in the model were based on the spot rates in effect as of February 3, 2018. The sensitivity analysis indicated that a hypothetical 10 percent adverse movement in foreign currency exchange rates would have an unfavorable impact on the underlying cash flow, net of our foreign exchange derivative financial instruments, of $40 million as of February 3, 2018.

Debt
Certain financial information about the Company's debt is set forth under the heading "Debt" in Note 4 of Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Form 10-K.
Our $1.25 billion aggregate principal amount of 5.95 percent notes due April 2021 are not subject to interest rate risk as they have a fixed interest rate.
A final repayment of 7.5 billion Japanese yen for the 15 billion Japanese yen, four-year, unsecured Japan Term Loan due January 2018 was fully repaid in June 2017.

Cash Equivalents
We have highly liquid fixed and variable income investments classified as cash equivalents, which are placed primarily in time deposits and money market funds. We value these investments at their original purchase prices plus interest that has accrued at the stated rate. The value of our investments is not subject to material interest rate risk. However, changes in interest rates would impact the interest income derived from our investments. We earned interest income of $19 million in fiscal 2017.

33


Item 8. Financial Statements and Supplementary Data.
THE GAP, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
 



34


Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors of The Gap, Inc.
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of The Gap, Inc. and subsidiaries (the “Company”) as of February 3, 2018 and January 28, 2017, the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows, for each of the fiscal years ended February 3, 2018, January 28, 2017 and January 30, 2016, and the related notes (collectively referred to as the “financial statements”). We also have audited the Company's internal control over financial reporting as of February 3, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of February 3, 2018 and January 28, 2017, and the results of its operations and its cash flows for each of the fiscal years ended February 3, 2018, January 28, 2017 and January 30, 2016, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of February 3, 2018, based on Internal Control - Integrated Framework (2013) issued by COSO.
Basis for Opinions
The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

35


Definition and Limitations of Internal Control over Financial Reporting
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Deloitte & Touche LLP
San Francisco, California
March 20, 2018
We have served as the Company’s auditor since at least 1976, in connection with its initial public offering.


36


THE GAP, INC.
CONSOLIDATED BALANCE SHEETS
 
($ and shares in millions except par value)
 
February 3,
2018
 
January 28,
2017
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
1,783

 
$
1,783

Merchandise inventory
 
1,997

 
1,830

Other current assets
 
788

 
702

Total current assets
 
4,568

 
4,315

Property and equipment, net
 
2,805

 
2,616

Other long-term assets
 
616

 
679

Total assets
 
$
7,989

 
$
7,610

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Current maturities of debt
 
$

 
$
65

Accounts payable
 
1,181

 
1,243

Accrued expenses and other current liabilities
 
1,270

 
1,113

Income taxes payable
 
10

 
32

Total current liabilities
 
2,461

 
2,453

Long-term liabilities:
 
 
 
 
Long-term debt
 
1,249

 
1,248

Lease incentives and other long-term liabilities
 
1,135

 
1,005

Total long-term liabilities
 
2,384

 
2,253

Commitments and contingencies (see Notes 11 and 15)
 
 
 
 
Stockholders' equity:
 
 
 
 
Common stock $0.05 par value
 
 
 
 
Authorized 2,300 shares for all periods presented; Issued and Outstanding 389 and 399 shares
 
19

 
20

Additional paid-in capital
 
8


81

Retained earnings
 
3,081

 
2,749

Accumulated other comprehensive income
 
36

 
54

Total stockholders' equity
 
3,144

 
2,904

Total liabilities and stockholders' equity
 
$
7,989

 
$
7,610

 










See Accompanying Notes to Consolidated Financial Statements

37


THE GAP, INC.
CONSOLIDATED STATEMENTS OF INCOME
 
  
 
Fiscal Year
($ and shares in millions except per share amounts)
 
2017
 
2016
 
2015
Net sales
 
$
15,855

 
$
15,516

 
$
15,797

Cost of goods sold and occupancy expenses
 
9,789

 
9,876

 
10,077

Gross profit
 
6,066

 
5,640

 
5,720

Operating expenses
 
4,587

 
4,449

 
4,196

Operating income
 
1,479

 
1,191

 
1,524

Interest expense
 
74

 
75

 
59

Interest income
 
(19
)
 
(8
)
 
(6
)
Income before income taxes
 
1,424

 
1,124

 
1,471

Income taxes
 
576

 
448

 
551

Net income
 
$
848

 
$
676

 
$
920

Weighted-average number of shares—basic
 
393

 
399

 
411

Weighted-average number of shares—diluted
 
396

 
400

 
413

Earnings per share—basic
 
$
2.16

 
$
1.69

 
$
2.24

Earnings per share—diluted
 
$
2.14

 
$
1.69

 
$
2.23

 




























See Accompanying Notes to Consolidated Financial Statements

38


THE GAP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
 
 
Fiscal Year
($ in millions)
 
2017
 
2016
 
2015
Net income
 
$
848

 
$
676

 
$
920

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
Foreign currency translation, net of tax benefit of $-, $-, and $(1)
 
35

 
7

 
(38
)
Change in fair value of derivative financial instruments, net of tax (tax benefit) of $(9), $(2), and $21
 
(51
)
 
(26
)
 
60

Reclassification adjustment for gains on derivative financial instruments, net of (tax) tax benefit of $3, $(11), and $(42)
 
(2
)
 
(12
)
 
(102
)
Other comprehensive loss, net of tax
 
(18
)
 
(31
)
 
(80
)
Comprehensive income
 
$
830

 
$
645

 
$
840



































See Accompanying Notes to Consolidated Financial Statements

39


THE GAP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
 
 
Common Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income
 
 
($ and shares in millions except per share amounts)
 
Shares
 
Amount
 
Total
Balance as of January 31, 2015
 
421

 
$
21

 
$

 
$
2,797

 
$
165

 
$
2,983

Net income
 
 
 
 
 
 
 
920

 
 
 
920

Other comprehensive loss, net of tax
 
 
 
 
 
 
 
 
 
(80
)
 
(80
)
Repurchases and retirement of common stock
 
(30
)
 
(1
)
 
(99
)
 
(900
)
 
 
 
(1,000
)
Issuance of common stock related to stock options and employee stock purchase plans
 
3

 

 
65

 
 
 
 
 
65

Issuance of common stock and withholding tax payments related to vesting of stock units
 
3

 

 
(69
)
 
 
 
 
 
(69
)
Tax benefit from exercise of stock options and vesting of stock units
 


 


 
26

 


 
 
 
26

Share-based compensation, net of estimated forfeitures
 
 
 
 
 
77

 
 
 
 
 
77

Common stock dividends ($0.92 per share)
 
 
 
 
 


 
(377
)
 
 
 
(377
)
Balance as of January 30, 2016
 
397

 
20

 

 
2,440

 
85

 
2,545

Net income
 


 


 


 
676

 


 
676

Other comprehensive loss, net of tax
 
 
 
 
 
 
 


 
(31
)
 
(31
)
Issuance of common stock related to stock options and employee stock purchase plans
 
1

 

 
29

 
 
 
 
 
29

Issuance of common stock and withholding tax payments related to vesting of stock units
 
1

 

 
(19
)
 
 
 
 
 
(19
)
Tax benefit from exercise of stock options and vesting of stock units
 
 
 
 
 
(4
)
 
 
 
 
 
(4
)
Share-based compensation, net of estimated forfeitures
 
 
 
 
 
75

 
 
 
 
 
75

Common stock dividends ($0.92 per share)
 
 
 
 
 
 
 
(367
)
 
 
 
(367
)
Balance as of January 28, 2017
 
399

 
20

 
81

 
2,749

 
54

 
2,904

Cumulative effect of a change in accounting principle related to stock-based compensation
 


 


 
(5
)
 
3

 


 
(2
)
Net income
 
 
 
 
 
 
 
848

 
 
 
848

Other comprehensive loss, net of tax
 
 
 
 
 
 
 
 
 
(18
)
 
(18
)
Repurchases and retirement of common stock
 
(13
)
 
(1
)
 
(156
)
 
(158
)
 
 
 
(315
)
Issuance of common stock related to stock options and employee stock purchase plans
 
2

 

 
30

 
 
 
 
 
30

Issuance of common stock and withholding tax payments related to vesting of stock units
 
1

 

 
(18
)
 
 
 
 
 
(18
)
Share-based compensation, net of forfeitures
 
 
 
 
 
76

 
 
 
 
 
76

Common stock dividends ($0.92 per share)
 
 
 
 
 
 
 
(361
)
 
 
 
(361
)
Balance as of February 3, 2018
 
389

 
$
19

 
$
8

 
$
3,081

 
$
36

 
$
3,144


See Accompanying Notes to Consolidated Financial Statements

40


THE GAP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS

 
 
Fiscal Year
($ in millions)
 
2017
 
2016
 
2015
Cash flows from operating activities:
 
 
 
 
 
 
Net income
 
$
848

 
$
676

 
$
920

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
 
Depreciation and amortization
 
559

 
593

 
592

Amortization of lease incentives
 
(60
)
 
(62
)
 
(65
)
Share-based compensation
 
87

 
76

 
76

Tax benefit from exercise of stock options and vesting of stock units
 

 
(4
)
 
26

Excess tax benefit from exercise of stock options and vesting of stock units
 

 
(1
)
 
(28
)
Store asset impairment charges
 
28

 
107

 
54

Goodwill impairment charge
 

 
71

 

Non-cash and other items
 
19

 
(4
)
 
(126
)
Deferred income taxes
 
61

 
(54
)
 
101

Changes in operating assets and liabilities:
 
 
 
 
 
 
Merchandise inventory
 
(142
)
 
46

 
(6
)
Other current assets and other long-term assets
 
33

 
54

 
133

Accounts payable
 
(90
)
 
146

 
(47
)
Accrued expenses and other current liabilities
 
34

 
76

 
(41
)
Income taxes payable, net of prepaid and other tax-related items
 
(52
)
 
19

 
(24
)
Lease incentives and other long-term liabilities
 
55

 
(20
)
 
29

Net cash provided by operating activities
 
1,380

 
1,719

 
1,594

Cash flows from investing activities:
 
 
 
 
 
 
Purchases of property and equipment
 
(731
)
 
(524
)
 
(726
)
Insurance proceeds related to loss on property and equipment
 
66

 

 

Other
 
(3
)
 
(5
)
 
(4
)
Net cash used for investing activities
 
(668
)
 
(529
)
 
(730
)
Cash flows from financing activities:
 
 
 
 
 
 
Proceeds from issuance of debt
 

 

 
400

Payments of debt
 
(67
)
 
(421
)
 
(21
)
Proceeds from issuances under share-based compensation plans
 
30

 
29

 
65

Withholding tax payments related to vesting of stock units
 
(18
)
 
(19
)
 
(69
)
Repurchases of common stock
 
(315
)
 

 
(1,015
)
Excess tax benefit from exercise of stock options and vesting of stock units
 

 
1

 
28

Cash dividends paid
 
(361
)
 
(367
)
 
(377
)
Other
 

 

 
(1
)
Net cash used for financing activities
 
(731
)
 
(777
)
 
(990
)
Effect of foreign exchange rate fluctuations on cash and cash equivalents
 
19

 

 
(19
)
Net increase (decrease) in cash and cash equivalents
 

 
413

 
(145
)
Cash and cash equivalents at beginning of period
 
1,783

 
1,370

 
1,515

Cash and cash equivalents at end of period
 
$
1,783

 
$
1,783

 
$
1,370

Non-cash investing activities:
 
 
 
 
 
 
Purchases of property and equipment not yet paid at end of period
 
$
77

 
$
56

 
$
81

Supplemental disclosure of cash flow information:
 
 
 
 
 
 
Cash paid for interest during the period
 
$
76

 
$
82

 
$
78

Cash paid for income taxes during the period, net of refunds
 
$
570

 
$
488

 
$
452

See Accompanying Notes to Consolidated Financial Statements

41


Notes to Consolidated Financial Statements
For the Fiscal Years Ended February 3, 2018, January 28, 2017, and January 30, 2016
Note 1. Organization and Summary of Significant Accounting Policies
Organization
The Gap, Inc., a Delaware corporation, is a global omni-channel retailer offering apparel, accessories, and personal care products for men, women, and children under the Old Navy, Gap, Banana Republic, Athleta, and Intermix brands. We have Company-operated stores in the United States, Canada, the United Kingdom, France, Ireland, Japan, Italy, China, Hong Kong, Taiwan, and Mexico. We also have franchise agreements with unaffiliated franchisees to operate Old Navy, Gap, and Banana Republic stores in approximately 36 other countries around the world. In addition, our products are available to customers online through Company-owned websites and through the use of third parties that provide logistics and fulfillment services.

Principles of Consolidation
The Consolidated Financial Statements include the accounts of The Gap, Inc. and its subsidiaries. All intercompany transactions and balances have been eliminated.

Fiscal Year and Presentation
Our fiscal year is a 52-week or 53-week period ending on the Saturday closest to January 31. The fiscal year ended February 3, 2018 (fiscal 2017) consisted of 53 weeks. The fiscal years ended January 28, 2017 (fiscal 2016) and January 30, 2016 (fiscal 2015) consisted of 52 weeks.

Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP 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 Cash Equivalents
Cash includes funds deposited in banks and amounts in transit from banks for customer credit card and debit card transactions that process in less than seven days.
All highly liquid investments with original maturities of 91 days or less are classified as cash equivalents. Our cash equivalents are placed primarily in time deposits and money market funds. We value these investments at their original purchase prices plus interest that has accrued at the stated rate. Income related to these securities is recorded in interest income in the Consolidated Statements of Income.

Merchandise Inventory
We value inventory at the lower of cost or net realizable value, with cost determined using the weighted-average cost method. We record an adjustment when future estimated selling price is less than cost. We review our inventory levels in order to identify slow-moving merchandise and broken assortments (items no longer in stock in a sufficient range of sizes or colors) and use promotions and markdowns to clear merchandise. In addition, we estimate and accrue shortage for the period between the last physical count and the balance sheet date.

Derivative Financial Instruments
Derivative financial instruments are recorded at fair value in the Consolidated Balance Sheets as other current assets, other long-term assets, accrued expenses and other current liabilities, or lease incentives and other long-term liabilities.

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For derivative financial instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative financial instruments is reported as a component of other comprehensive income (“OCI”) and is recognized in income in the period in which the underlying transaction impacts the income statement. For derivative financial instruments that are designated and qualify as net investment hedges, the effective portion of the gain or loss on the derivative financial instruments is reported as a component of OCI and is reclassified into income in the period or periods during which the hedged subsidiary is either sold or liquidated (or substantially liquidated). Gains and losses on the derivative financial instruments representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness, if any, are recognized in current income. For derivative financial instruments not designated as hedging instruments, the gain or loss on the derivative financial instruments is recorded in operating expenses in the Consolidated Statements of Income. Cash flows from derivative financial instruments are classified as cash flows from operating activities in the Consolidated Statements of Cash Flows.

Property and Equipment
Depreciation is computed using the straight-line method over the estimated useful lives of the related assets. Estimated useful lives are as follows: