Forward-Looking Statements

This Quarterly Report on Form 10-Q 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," "plan," "project," and similar expressions also identify forward-looking statements. Forward-looking statements include, but are not limited to, statements regarding: (i) future amortization expense for intangible assets subject to amortization; (ii) expected lease payments related to the discontinued operation of Forth & Towne; (iii) expected share repurchases from members of the Fisher family; (iv) the decrease in unrecognized tax benefits;
(v) the maximum potential amount of future lease payments under assigned leases;
(vi) the impact of losses under contractual indemnifications; (vii) the maximum exposure and cash collateralized balance for the Company's reinsurance pool in future periods; (viii) the effect of various proceedings, lawsuits, disputes and claims; (ix) expanding into the women's active apparel sector through the acquisition of Athleta; (x) continued deterioration of macroeconomic conditions;
(xi) managing inventory to support healthy gross margin; (xii) improving return on invested capital; (xiii) distributing excess cash to shareholders;
(xiv) interest expense for fiscal 2008; (xv) effective tax rate for fiscal 2008;
(xvi) purchases of property and equipment for fiscal 2008; (xvii) number of new store openings and store closings in fiscal 2008; (xviii) net square footage change in fiscal 2008; (xix) net cash provided by operating activities for fiscal 2008; (xx) free cash flow for fiscal 2008; (xxi) cash balances, cash flows and liquidity being sufficient for the foreseeable future and through a prolonged downturn; and (xxii) consideration of future dividends.

Because these forward-looking statements involve risks and uncertainties, there are important factors that could cause the Company's actual results to differ materially from those in the forward-looking statements. These factors include, without limitation, the following: the risk that the adoption of new accounting pronouncements will impact future results; the risk that the Company will be unsuccessful in gauging fashion trends and changing consumer preferences; the risk that changes in general economic conditions, consumer confidence, or consumer spending patterns will have a negative impact on the Company's financial performance or strategies; the highly competitive nature of the Company's business in the United States and internationally and its dependence on consumer spending patterns, which are influenced by numerous other factors; the risk that the Company will be unsuccessful in identifying and negotiating new store locations and renewing leases for existing store locations effectively; the risk that comparable store sales and margins will experience fluctuations; the risk that the Company will be unsuccessful in implementing its strategic, operating and people initiatives; the risk that adverse changes in the Company's credit ratings may have a negative impact on its financing costs, structure and access to capital in future periods; the risk that changes to the Company's information technology systems may disrupt its operations; the risk that trade matters, events causing disruptions in product shipments from China and other foreign countries, or an inability to secure sufficient manufacturing capacity may disrupt the Company's supply chain or operations; the risk that the Company's efforts to expand internationally through franchising and similar arrangements may not be successful and could impair the value of its brands; the risk that acts or omissions by the Company's third party vendors, including a failure to comply with the Company's code of vendor conduct, could have a negative impact on the Company's reputation or operations; the risk that the Company does not repurchase some or all of the shares it anticipates purchasing pursuant to its repurchase program; and the risk that the Company will not be successful in defending various proceedings, lawsuits, disputes, claims, and audits; any of which could impact net sales, costs and expenses, and/or planned strategies. Additional information regarding factors that could cause results to differ can be found in the Company's Annual Report on Form 10-K for the fiscal year ended February 2, 2008.

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 December 9, 2008 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.

We suggest that this document be read in conjunction with Management's Discussion and Analysis included in our Annual Report on Form 10-K for the fiscal year ended February 2, 2008.

Our Business

We are a leading global specialty retailer operating retail and online stores selling clothing, accessories, and personal care products for men, women, children, and babies under the Gap, Banana Republic, Old Navy, Piperlime, and Athleta brand names. We operate stores in the United States, Canada, the United Kingdom, France, Ireland, and Japan. We also have franchise agreements with unaffiliated franchisees to operate Gap and Banana Republic stores in Asia, Europe, Latin America, and the Middle East. Under these agreements, third parties operate or will operate stores that sell apparel, purchased from us, under our brand names. In addition, our U.S. customers can shop online at www.gap.com, www.bananarepublic.com, www.oldnavy.com, www.piperlime.com, and www.athleta.com.

In September 2008, we acquired all of the outstanding capital stock of Athleta, Inc. ("Athleta"), a women's sports and active apparel company based in Petaluma, California, for an aggregate purchase price of $147 million. The acquisition will allow us to enhance our

presence in the growing women's active apparel sector in the United States. We believe this acquisition complements our brands and allows us to leverage our new online platform to expand into this significant retail sector.

Overview

Financial highlights include:

• Net sales for the third quarter of fiscal 2008 were $3.6 billion compared with $3.9 billion for the third quarter of fiscal 2007, and comparable store sales decreased 12 percent compared with a decrease of 5 percent in the third quarter of fiscal 2007.

• Net earnings for the third quarter of fiscal 2008 were $246 million, or $0.35 per share on a diluted basis, compared with $238 million, or $0.30 per share on a diluted basis for the third quarter of fiscal 2007.

• Gross margin for the third quarter of fiscal 2008 was 38.7 percent compared with 37.5 percent for the third quarter of fiscal 2007.

• Our Direct sales for the third quarter of fiscal 2008 increased 15 percent to $284 million, compared with $247 million for the third quarter of fiscal 2007. Direct includes all online sales and, beginning September 2008, Athleta online and catalog sales.

• We generated cash flows from operating activities of $834 million during the thirty-nine weeks ended November 1, 2008. Our capital expenditures for the thirty-nine weeks ended November 1, 2008 were $315 million.

• For the thirty-nine weeks ended November 1, 2008, we generated free cash flow of $519 million, compared with $484 million for the thirty-nine weeks ended November 3, 2007. Free cash flow is defined as net cash provided by operating activities less purchases of property and equipment. For a reconciliation of free cash flow, a non-GAAP financial measure, from a GAAP financial measure, see the Financial Condition section in this Management's Discussion and Analysis.

• We repurchased approximately 6 million shares of our common stock for a total of $100 million under our share repurchase program in the third quarter of fiscal 2008. We also declared and paid a cash dividend of $0.085 per share in the third quarter of fiscal 2008.

Macroeconomic conditions deteriorated in the third quarter and we believe that these conditions will continue in the fourth quarter. Our cash flow generation remains healthy and we have a strong balance sheet. As of November 1, 2008, cash, cash equivalents and short-term investments were $1.6 billion and long-term debt, all of which is classified as current, was $188 million. We believe our cash balances and cash flows from operations will be sufficient for the foreseeable future. During this challenging economic environment we are focused on the following priorities:

• Consistently deliver product that aligns with our target customers.

• Maintain a focus on cost management and operational improvements that allow us to work more simply and efficiently.

• Improve the customer experience and continue to invest in the fleet in a manner that supports improvement in return on invested capital.

• Manage inventory to support healthy gross margin.

• Maintain sufficient cash balances and liquidity to sustain us through a prolonged downturn.

• Distribute excess cash to shareholders in the form of dividends and share repurchases.

Also see the section entitled "Risk Factors-The recent changes in general economic conditions, and the impact on consumer confidence and consumer spending, could adversely impact our results of operations" in Item 1A of Part II of this Form 10-Q.

RESULTS OF OPERATIONS

Net Sales

Net Sales by Brand, Region, and Channel

Net sales primarily consist of retail sales, online sales, and shipping fees
received from customers for delivery of merchandise. Outlet retail sales are
reflected within the respective results of each brand. Net sales by brand,
region, and channel for the thirteen and thirty-nine weeks ended November 1,
2008 and November 3, 2007 are as follows:



($ in millions)                                                  Banana
13 Weeks Ended November 1, 2008     Gap         Old Navy        Republic        Other (3)       Total
U.S. (1)                          $   976      $    1,136      $      527      $        -      $  2,639
Canada                                 90              96              39               -           225
Europe                                181              -                6               13          200
Asia                                  159              -               23               12          194
Other Regions                          -               -               -                19           19
Direct (2)                             95             131              37               21          284

Total                             $ 1,501      $    1,363      $      632      $        65     $  3,561


Global Sales Growth (Decline)          (4 )%          (15 )%           (5 )%            91 %         (8 )%

                                                                 Banana
13 Weeks Ended November 3, 2007     Gap         Old Navy        Republic        Other (3)       Total
U.S. (1)                          $ 1,040      $    1,356      $      567      $        -      $  2,963
Canada                                101             124              40               -           265
Europe                                197              -               -                 3          200
Asia                                  136              -               22               10          168
Other Regions                          -               -               -                11           11
Direct (2)                             83             118              36               10          247

Total                             $ 1,557      $    1,598      $      665      $        34     $  3,854


Global Sales Growth (Decline)          (2 )%           (3 )%           10 %            240 %         -  %

                                                                 Banana
39 Weeks Ended November 1, 2008     Gap         Old Navy        Republic        Other (3)       Total
U.S. (1)                          $ 2,794      $    3,472      $    1,593      $        -      $  7,859
Canada                                247             294             110               -           651
Europe                                538              -               17               25          580
Asia                                  487              -               69               35          591
Other Regions                          -               -               -                52           52
Direct (2)                            230             340             100               41          711

Total                             $ 4,296      $    4,106      $    1,889      $       153     $ 10,444


Global Sales Growth (Decline)          (2 )%          (14 )%           -  %             87 %         (6 )%

                                                                 Banana
39 Weeks Ended November 3, 2007     Gap         Old Navy        Republic        Other (3)       Total
U.S. (1)                          $ 2,931      $    4,129      $    1,634      $        -      $  8,694
Canada                                252             324              99               -           675
Europe                                581              -               -                 3          584
Asia                                  401              -               63               25          489
Other Regions                          -               -               -                32           32
Direct (2)                            206             294              92               22          614

Total                             $ 4,371      $    4,747      $    1,888      $        82     $ 11,088


Global Sales Growth (Decline)          (2 )%           (1 )%           10 %            310 %          1 %

(1) U.S. includes the United States and Puerto Rico.

(2) U.S. only. Direct includes Athleta online and catalog sales beginning September 2008.

(3) Other includes our wholesale business, franchise business, Piperlime, and, beginning September 2008, Athleta online and catalog sales.

Comparable Store Sales

A store is included in comparable store sales ("Comp") when it has been open at least one year and the square footage has not changed by 15 percent or more within the past year. A store is included in Comp on the first day it has comparable prior year sales. Stores in which square footage has changed by 15 percent or more as a result of a remodel, expansion, or reduction are excluded from Comp until the first day they have comparable prior year sales. Current year foreign exchange rates are applied to both current year and prior year Comp store sales to achieve a consistent basis for comparison.

A store is considered non-comparable ("Non-comp") when it has been open for less than one year or it has changed its square footage by 15 percent or more within the past year. Non-store sales such as online revenues are also considered Non-comp.

A store is considered "Closed" if it is temporarily closed for three or more full consecutive days or 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 then the store will be in Non-comp status for the same days in the following year.

The differences between net sales for the thirteen and thirty-nine weeks ended November 1, 2008 and net sales for the thirteen and thirty-nine weeks ended November 3, 2007 are classified as follows:

                                                                              Banana
($ in millions)                      Gap (3)(4)       Old Navy (3)        Republic (3)(4)        Other (5)      Total
13 Weeks Ended November 3, 2007     $      1,557      $       1,598      $             665      $        34    $  3,854
Increase (decrease) in:
Comparable stores                            (75 )             (248 )                  (67 )             -         (390 )
Non-comparable and closed stores              17                  6                     33               20          76
Direct (1)                                    12                 13                      1               11          37
Foreign exchange (2)                         (10 )               (6 )                   -                -          (16 )

13 Weeks Ended November 1, 2008     $      1,501      $       1,363      $             632      $        65    $  3,561


                                                                              Banana
                                     Gap (3)(4)       Old Navy (3)        Republic (3)(4)        Other (5)      Total
39 Weeks Ended November 3, 2007     $      4,371      $       4,747      $           1,888      $        82    $ 11,088
Increase (decrease) in:
Comparable stores                           (227 )             (728 )                 (132 )             -       (1,087 )
Non-comparable and closed stores              70                 27                    113               52         262
Direct (1)                                    24                 46                      8               19          97
Foreign exchange (2)                          58                 14                     12               -           84

39 Weeks Ended November 1, 2008     $      4,296      $       4,106      $           1,889      $       153    $ 10,444

(1) Includes Athleta online and catalog sales beginning September 2008.

(2) Foreign exchange is the translation impact if prior year sales were translated at current year exchange rates.

(3) Includes United States, Puerto Rico, and Canada.

(4) Includes international stores.

(5) Includes our wholesale business, franchise business, Piperlime, and, beginning September 2008, Athleta online and catalog sales.

Our net sales for the third quarter of fiscal 2008 decreased $293 million, or 8 percent, compared with the prior year comparable period. Our comparable store sales decreased 12 percent for the third quarter of fiscal 2008. The 4 percentage point difference between net sales and comparable store sales includes the impact of new stores, foreign exchange, and a 15 percent increase in Direct sales for the third quarter of fiscal 2008 from the prior year comparable period. Overall, our store square footage increased 0.5 percent in the third quarter of fiscal 2008 from the prior year comparable period and sales productivity was $81 per average square foot for the third quarter of fiscal 2008 compared with $91 per average square foot for the prior year comparable period. During the third quarter of fiscal 2008, we opened 37 new stores and closed 17 stores.

Comparable store sales percentage by brand for the third quarter of fiscal 2008 over fiscal 2007 was as follows:

• Gap North America: negative 7 percent in fiscal 2008 versus negative 6 percent in fiscal 2007;

• Banana Republic North America: negative 11 percent in fiscal 2008 versus positive 1 percent in fiscal 2007;

• International: negative 1 percent in fiscal 2008 versus negative 4 percent in fiscal 2007.

Net sales for the thirty-nine weeks ended November 1, 2008 decreased $644 million, or 6 percent, from the prior year comparable period. Our comparable store sales decreased 11 percent for the thirty-nine weeks ended November 1, 2008. The 5 percentage point difference between net sales and comparable store sales includes the impact of new stores, foreign exchange, and a 16 percent increase in Direct sales for the thirty-nine weeks ended November 1, 2008 from the prior year comparable period. Overall, our store square footage increased 0.8 percent from the end of fiscal 2007 and sales productivity was $242 per average square foot for the thirty-nine weeks ended November 1, 2008 compared with $266 per average square foot for the prior year comparable period. During the thirty-nine weeks ended November 1, 2008, we opened 92 new stores and closed 69 stores. These numbers include 16 store repositions, which are reflected as both an opening and a closing.

Comparable store sales percentage by brand for the thirty-nine weeks ended November 1, 2008 over fiscal 2007 was as follows:

• Gap North America: negative 7 percent in fiscal 2008 versus negative 5 percent in fiscal 2007;

• Banana Republic North America: negative 7 percent in fiscal 2008 versus positive 1 percent in fiscal 2007;

• Old Navy North America: negative 17 percent in fiscal 2008 versus negative 7 percent in fiscal 2007; and

• International: negative 4 percent in fiscal 2008 versus negative 2 percent in fiscal 2007.

Store Count and Square Footage

Store count and square footage for our wholly owned stores were as follows:



                                             November 1, 2008                             November 3, 2007
                                      Number of           Square Footage           Number of           Square Footage
                                   Store Locations        (in millions)         Store Locations        (in millions)
Gap North America                            1,227                  12.1                  1,278                  12.4
Gap Europe                                     173                   1.5                    172                   1.5
Gap Asia                                       112                   1.1                    109                   1.0
Old Navy North America                       1,076                  20.2                  1,062                  20.0
Banana Republic North America                  573                   4.9                    549                   4.7
Banana Republic Asia                            26                   0.1                     21                   0.1
Banana Republic Europe                           3                    -                      -                     -

Total                                        3,190                  39.9                  3,191                  39.7

Increase over Prior Year (1)                    -  %                 0.5 %                  1.6 %                 2.1 %

(1) Computation excludes store locations and square footage associated with the discontinued operation of Forth & Towne.

Outlet stores are reflected in each of the respective brands in the table above. We also have franchise agreements with unaffiliated franchisees to operate Gap and Banana Republic stores in Asia, Europe, Latin America, and the Middle East. We had 113 and 48 franchise stores open as of November 1, 2008 and November 3, 2007, respectively.

Cost of Goods Sold and Occupancy Expenses

Cost of goods sold and occupancy expenses include:

• the cost of merchandise;

• inventory shortage and valuation adjustments;

• freight charges;

• costs associated with our sourcing operations, including payroll and related benefits;

• production costs;

• insurance costs related to merchandise; and

• occupancy, rent, common area maintenance, real estate taxes, utilities, and depreciation for our stores and distribution centers.

The classification of these expenses varies across the retail industry.

                                                                                                                                               Percentage of Net Sales
                                                                13 Weeks Ended                      39 Weeks Ended                   13 Weeks Ended                39 Weeks Ended
                                                         November 1,       November 3,       November 1,       November 3,     November 1,    November 3,    November 1,    November 3,
($ in millions)                                             2008              2007              2008              2007            2008           2007           2008           2007
Cost of Goods Sold and Occupancy Expenses              $         2,183    $       2,407    $         6,386    $       7,022       61.3%          62.5%          61.1%          63.3%
Gross Profit                                           $         1,378    $       1,447    $         4,058    $       4,066       38.7%          37.5%          38.9%          36.7%

Cost of goods sold and occupancy expenses as a percentage of net sales decreased 1.2 percentage points in the third quarter of fiscal 2008 and decreased 2.2 percentage points during the thirty-nine weeks ended November 1, 2008 compared with the prior year comparable periods.

Cost of goods sold decreased $234 million, or 2.7 percentage points as a percentage of net sales, in the third quarter of fiscal 2008 and decreased $706 million, or 3.8 percentage points as a percentage of net sales, during the thirty-nine weeks ended November 1, 2008 compared with the prior year comparable periods. The decrease was driven primarily by a higher margin for both regular price and marked down merchandise.

Occupancy expenses increased $10 million, or 1.5 percentage points as a percentage of net sales, in the third quarter of fiscal 2008 and increased $70 million, or 1.6 percentage points as a percentage of net sales, during the thirty-nine weeks ended November 1, 2008 compared with the prior year comparable periods. The increase was primarily driven by costs related to new and existing stores, partially offset by savings from store closures.

Operating Expenses

Operating expenses include:

• payroll and related benefits (for our store operations, field management, distribution centers, and corporate functions);

• advertising;

• general and administrative expenses;

• costs to design and develop our products;

• merchandise handling and receiving in distribution centers and stores;

• distribution center general and administrative expenses;

• rent, occupancy, and depreciation for headquarter facilities; and

• other expense (income).

The classification of these expenses varies across the retail industry.

                                                                                                                             Percentage of Net Sales
                                         13 Weeks Ended                       39 Weeks Ended                     13 Weeks Ended                  39 Weeks Ended
                                 November 1,        November 3,        November 1,        November 3,      November 1,     November 3,     November 1,     November 3,
($ in millions)                      2008              2007               2008               2007             2008            2007            2008            2007
Operating Expenses              $          984     $       1,079     $         2,908     $       3,169        27.6%           28.0%           27.8%           28.6%
. . .