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G A P I N C . F I N A N C I A L S 2 0 0 5
22 gap inc. 2005 annual report
Operating Expenses, Excluding Loss on Early Retirement of Debt
Operating expenses include payroll and related benefits (for our store operations, field management, distribution centers, and corporate functions),
advertising, and general and administrative expenses. Also included are costs to design and develop our products, merchandise handling and re-
ceiving in distribution centers and stores, distribution center general and administrative expenses, and rent, occupancy, and depreciation for head-
quarter facilities.
Operating expenses as a percentage of net sales decreased 0.7 percentage points, or $172 million, in fiscal 2005 compared with fiscal 2004. The de-
crease was primarily driven by a $61 million net reversal of sublease loss reserve in the second quarter of fiscal 2005 and the reclassification of certain
sourcing expenses. While we have been classifying the majority of sourcing expenses in cost of goods sold and occupancy expenses, some operating
costs related to certain wholly owned agent offices that source our product had been classified in operating expenses. As a result, approximately $42
million of year to date sourcing expenses were reclassified in fiscal 2005. This reclassification had no effect on net earnings. Lower advertising ex-
penses primarily driven by our decision not to run a holiday television campaign at Gap brand and lower bonus expense related to fiscal 2005 perfor-
mance also contributed to the decrease in operating expenses.
Operating expenses as a percentage of net sales increased 0.7 percentage points, or $228 million, in fiscal 2004 compared with fiscal 2003. The in-
crease was primarily due to higher store payroll and benefits to support increased sales, planned increases for new growth initiatives and increased
advertising expenses. Gap North America ran incremental television campaigns compared to the prior year and Old Navy increased its circulars to
promote sales.
Operating margin, excluding loss on early retirement of debt, was 10.9 percent, 12.8 percent, and 12.0 percent in fiscal 2005, 2004 and 2003, respec-
tively. For fiscal 2006, we expect operating margin to be about 10.0 to 10.5 percent, including the impact of the adoption of SFAS 123(R).
Included in operating expenses are costs related to store closures and sublease loss reserves. The following discussion should be read in conjunction
with Note E to the Consolidated Financial Statements.
During the second fiscal quarter of 2005 we completed our assessment of available space and future office facility needs and decided that we would
occupy one of our vacant leased properties in San Francisco. As a result, in the same quarter the sublease loss reserve of $58 million associated with
this space at April 30, 2005 was reversed and planning efforts to design and construct leasehold improvements for occupation in 2006 began. We
further reduced the reserve by $3 million based on our decision to occupy certain additional office space.
In prior years, we considered our headquarter facilities’ space needs and identified and abandoned excess facility space. As a result of these actions,
we recorded sublease loss charges of $77 million in fiscal 2002. During fiscal 2004 and 2003, due to continued weakness in the commercial real estate
market, we revised our sublease income and sublease commencement projections and assumptions related to headquarter facilities in our San Fran-
cisco and San Bruno campuses and recorded additional sublease loss charges of $5 million and $9 million, respectively.
In August 2004, we sold our stores and exited the market in Germany. In fiscal 2003, we recognized a charge to operating expense of $14 million for
asset write-downs. The actual net selling price approximated our initial estimate. This decision represented a strategic move toward re-allocating our
international resources to optimize growth in our other existing markets and focusing our attention on more attractive, longer-term growth opportuni-
ties in new markets.
Percentage of Net Sales
52 Weeks Ended 52 Weeks Ended
($ in millions) Jan. 28, 2006 Jan. 29, 2005 Jan. 31, 2004 Jan. 28, 2006 Jan. 29, 2005 Jan. 31, 2004
Operating Expenses, Excluding
Loss on Early Retirement of Debt $ 4,124 $ 4,296 $ 4,068 25.7% 26.4% 25.7%