The Gap 2006 Annual Report Download - page 33

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
OVERVIEW
Fiscal 2006 was a challenging year for us. Net sales were $15.9 billion compared with $16.0 billion last
year, traffic was weak and comparable store sales decreased by 7 percent compared with a decrease of 5 percent
last year. While we saw progress at Banana Republic where customers responded well to our improved product
assortments, product acceptance at Gap and Old Navy brands continued to be a challenge. As a result, additional
promotions and markdowns drove a 4 percent decrease in gross profit from $5.9 billion in fiscal 2005 to
$5.6 billion in fiscal 2006. Piperlime.com was launched successfully in the third quarter and we opened
franchised stores in the Middle East and Asia. We invested in marketing and stores in an effort to turnaround our
business performance which contributed to a 9 percent increase in operating expenses from $4.1 billion in fiscal
2005 to $4.5 billion in fiscal 2006. Combined, these factors contributed to a 25 percent decrease in diluted
earnings per share of $0.93 for the 53 weeks ended February 3, 2007 compared with $1.24 for the 52 weeks
ended January 28, 2006.
Despite these disappointing results, we generated free cash flow of $678 million defined as the net cash
provided by operating activities less the purchase of property and equipment (for a reconciliation of free cash
flow, a non-GAAP measure, to a GAAP measure, see the Liquidity section in this Management’s Discussion and
Analysis). We utilized our excess cash to repurchase $1 billion of common stock, and increased our annual
dividend from $0.18 per share to $0.32 per share for a total of $265 million.
In 2007, we are focusing on three priorities: fixing our core business by creating the right product and store
experience, retaining and developing the best talent in the industry, and examining our organization structure to
ensure that we enable our brands to make decisions and effect change more efficiently. We remain committed to
returning excess cash to our stockholders through dividends and share repurchases, and maintaining sufficient
cash on the balance sheet to support the needs of our business and to withstand unanticipated business volatility.
Since January 2007, we have taken the following actions:
•Leadership changes. Our Board of Directors announced a change in the chief executive officer
position. Mr. Robert Fisher, our current non-employee chairman of the board of directors, stepped in to
serve as interim president and chief executive officer. In addition, we announced Marka Hansen,
former president of Banana Republic, as the new president of the Gap Brand and Michael Cape, former
Vice President, Director of Brand Marketing for J.C. Penney Company, Inc., as the new executive vice
president of marketing for the Old Navy brand.
•Conversion of Old Navy’s Outlet stores into Old Navy stores. In order to drive improved returns
and leverage its existing retail channel, we made the decision in February 2007 to convert 45 Old Navy
Outlet stores into Old Navy stores. We expect the conversion to be completed by October 2007.
•Closure of distribution facility. As part of our on-going assessment of network capacity, we made the
decision in February 2007 to close a distribution facility in Hebron, Kentucky. The expenses associated
with converting the Old Navy Outlet stores and closing the distribution center are expected to be
approximately $6 million in fiscal 2007.
•Closure of Forth & Towne. After a thorough analysis revealed that the concept was not demonstrating
enough potential to deliver acceptable long-term return on investment, we announced in February 2007
that we would close our Forth & Towne stores. We plan to close all 19 stores by the end of June 2007
and expect the pre-tax expenses associated with the closure to be approximately $40 million.
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