The Gap 2006 Annual Report Download - page 75

NOTE 10. EARNINGS PER SHARE
Basic earnings per share is computed using the weighted-average number of shares of common stock
outstanding during the period. Diluted earnings per share includes the additional dilutive effect of our potentially
dilutive securities, which includes certain stock options and unvested shares of stock options and Service
Awards, calculated using the treasury stock method, and convertible notes which are potentially dilutive at
certain earnings levels calculated using the if-converted method. The following summarizes the incremental
shares from the potentially dilutive securities:
($ in millions, shares in thousands)
53 Weeks Ended
February 3, 2007
52 Weeks Ended
January 28, 2006
52 Weeks Ended
January 29, 2005
Net earnings—basic ................................. $ 778 $ 1,113 $ 1,150
Add: Interest on convertible notes .................. — 8 49
Net earnings—diluted ................................ $ 778 $ 1,121 $ 1,199
Weighted-average number of shares—basic ............... 831,087 881,058 893,357
Incremental shares from:
Stock options and Service Awards .................. 4,886 8,240 12,244
Senior convertible notes .......................... — 13,008 85,521
Weighted-average number of shares—diluted ............. 835,973 902,306 991,122
Earnings per share—basic ............................. $ 0.94 $ 1.26 $ 1.29
Earnings per share—diluted ........................... $ 0.93 $ 1.24 $ 1.21
The above computations of weighted-average shares for diluted earnings per share exclude options to
purchase 42 million, 44 million, and 33 million shares of common stock for fiscal 2006, 2005, and 2004,
respectively, because the exercise price was greater than the average market price of the company’s common
stock during the period and, therefore, the effect is antidilutive.
NOTE 11. COMMITMENTS AND CONTINGENCIES
In January 2006, we entered into a non-exclusive services agreement with International Business Machines
Corporation (“IBM”). Under the services agreement, IBM operates certain aspects of our information technology
infrastructure that had been previously operated by us. The services agreement has an initial term of ten years,
and we have the right to renew it for up to three additional years. We have various options to terminate the
agreement, and we pay IBM under a combination of fixed and variable charges, with the variable charges
fluctuating based on our actual consumption of services. Based on the currently projected service needs, we
expect to pay approximately $1.1 billion to IBM over the initial 10-year term. We paid approximately
$118 million to IBM during 2006 and expect to pay $1 billion over the remaining nine years of the contract.
The services agreement has performance levels that IBM must meet or exceed. If these service levels are not
met, we would in certain circumstances receive a credit against the charges otherwise due, have the right to other
interim remedies, or as to material breaches have the right to terminate the services agreement. In addition, the
services agreement provides us certain pricing protections, and we have the right to terminate the agreement both
for cause and for convenience (subject, in the case of termination for convenience, to our payment of a
termination fee). IBM also has certain termination rights in the event of our material breach of the agreement and
failure to cure.
We have applied the measurement and disclosure provisions of FIN 45, “Guarantor’s Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of the Indebtedness of Others,” to our
agreements that contain guarantee and certain indemnification clauses. FIN 45 requires that upon issuance of a
guarantee, the guarantor must disclose and recognize a liability for the fair value of the obligation it assumes
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