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," "intend," "plan," "project," and similar expressions also identify forward-looking statements. Forward-looking statements include, but are not limited to, statements regarding the following:

• income recognition of unrealized gains and losses from designated cash flow hedges;

• changes in total gross unrecognized tax benefits within the next 12 months;

• the maximum potential amount of future lease payments;

• the impact of losses due to indemnification obligations;

• the outcome of proceedings, lawsuits, disputes, and claims;

• earnings per share for fiscal 2012;

• improving sales with healthy merchandise margins;

• investing in our business while maintaining discipline;

• returning excess cash to shareholders;

• improving comparable store sales;

• growing revenues;

• opening additional stores, including outlets, in Asia, Canada, and Europe;

• continuing to open franchise stores worldwide;

• opening additional Athleta stores;

• the number of new store openings and store closings in fiscal 2012, including franchise stores;

• net square footage change in fiscal 2012;

• depreciation and amortization expense in fiscal 2012;

• operating margin and the potential for leveraging operating expenses in fiscal 2012;

• the effective tax rate in fiscal 2012;

• current cash balances and cash flows being sufficient to support our business operations, including growth initiatives and planned capital expenditures;

• ability to supplement near-term liquidity, if necessary, with our $500 million revolving credit facility;

• the impact of the seasonality of our operations on certain asset and liability accounts;

• capital expenditures in fiscal 2012;

• the number of new franchise store openings in fiscal 2012;

• dividend payments in fiscal 2012; and

• the impact of changes in internal controls.

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 adoption of new accounting pronouncements will impact future results;

• the risk that changes in general economic conditions or consumer spending patterns could adversely impact our results of operations;

• the highly competitive nature of our business in the United States and internationally;

• the risk that we or our franchisees will be unsuccessful in gauging apparel trends and changing consumer preferences;

• the risk to our business associated with global sourcing and manufacturing, including sourcing costs, events causing disruptions in product shipment, or an inability to secure sufficient manufacturing capacity;

• the risk that our franchisees will be unable to successfully open, operate, and grow their franchised stores in a manner consistent with our requirements regarding our brand identities and customer experience standards;

• 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 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 and our ability to service our debt while maintaining other initiatives;

• 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 updates or changes to our information technology ("IT") systems may disrupt our operations;

• the risk that actual or anticipated cyber attacks, and other cybersecurity risks, may cause us to incur increasing costs;

• the risk that natural disasters, public health crises, political crises, or other catastrophic events could adversely affect our operations and financial results;

• the risk that acts or omissions by our third-party vendors, including a failure to comply with our code of vendor conduct, could have a negative impact on our reputation or operations;

• the risk that we do not repurchase some or all of the shares we anticipate purchasing pursuant to our share repurchase program;

• the risk that we will not be successful in defending various proceedings, lawsuits, disputes, claims, and audits; and

• the risk that changes in the regulatory or administrative landscape could adversely affect our financial condition, strategies, and results of operations.

Additional information regarding factors that could cause results to differ can be found in our Annual Report on Form 10-K for the fiscal year ended January 28, 2012 and our other filings with the U.S. Securities and Exchange Commission.

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 June 6, 2012, 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 January 28, 2012.

OUR BUSINESS

We are a leading global specialty apparel company. We offer apparel, accessories, and personal care products for men, women, children, and babies under the Gap, Old Navy, Banana Republic, Piperlime, and Athleta brands. We have Company-operated stores in the United States, Canada, the United Kingdom, France, Ireland, Japan, China, and Italy. We also have franchise agreements with unaffiliated franchisees to operate Gap and Banana Republic stores in many other countries around the world. 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 in over 90 countries through Company-owned websites and using third parties that provide logistics and fulfillment services. 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.

We identify our operating segments based on the way we manage and evaluate our business activities. We have two reportable segments: Stores and Direct.

OVERVIEW

Financial highlights for the first quarter of fiscal 2012 are as follows:

• Net sales for the first quarter of fiscal 2012 increased 6 percent to $3.5 billion compared with $3.3 billion for the first quarter of fiscal 2011. Comparable sales for the first quarter of fiscal 2012, which include the associated comparable online sales, increased 4 percent compared with a 3 percent decrease for the first quarter of fiscal 2011.

• Net sales outside of the U.S. and Canada (including Direct and franchise) increased 13 percent to $511 million for the first quarter of fiscal 2012 compared with $454 million for the first quarter of fiscal 2011.

• Gross profit for the first quarter of fiscal 2012 was $1.4 billion compared with $1.3 billion for the first quarter of fiscal 2011. Gross margin for the first quarter of fiscal 2012 was 39.4 percent compared with 39.6 percent for the first quarter of fiscal 2011.

• Operating expenses for the first quarter of fiscal 2012 were $980 million compared with $918 million for the first quarter of fiscal 2011 and increased 0.2 percent as a percentage of net sales.

• Net income for the first quarter of fiscal 2012 was $233 million, which was flat compared with $233 million for the first quarter of fiscal 2011; however, diluted earnings per share increased 18 percent to $0.47 for the first quarter of fiscal 2012 compared with $0.40 for the first quarter of fiscal 2011, driven primarily by our share repurchase activities throughout fiscal 2011. For fiscal 2012, we expect diluted earnings per share to be in the range of $1.78 to $1.83.

• During the first quarter of fiscal 2012, we generated free cash flow of $216 million compared with free cash flow of $104 million during the first quarter of fiscal 2011. 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 measure, from a GAAP financial measure, see the Liquidity and Capital Resources section.

Our full year business and financial priorities for fiscal 2012 remain as follows:

• improve sales with healthy merchandise margins;

• invest in our business while maintaining discipline; and

• return excess cash to shareholders.

As we focus on improving comparable store sales in fiscal 2012, we also plan to grow revenues through the following:

• opening additional stores, many of which will be outlets, in Asia, Canada, and Europe;

• continuing to open franchise stores worldwide; and

• opening additional Athleta stores.

RESULTS OF OPERATIONS

Net Sales

Net sales primarily consist of retail sales, online sales, and franchise revenues.

See Item 1, Financial Statements, Note 11 of Notes to Condensed Consolidated Financial Statements for net sales by brand, region, and reportable segment.

Comparable Sales

The percentage change in comparable ("Comp") sales by brand and region and for
total Company, including the associated comparable online sales, as compared
with the preceding year, is as follows:



                                                   13 Weeks Ended
                                            April 28,          April 30,
                                              2012                2011
           Gap North America                         5 %               (3 )%
           Old Navy North America                    4 %               (2 )%
           Banana Republic North America             5 %               (1 )%
           International                            (4 )%              (6 )%
           The Gap, Inc.                             4 %               (3 )%

The percentage change in Comp store sales by brand and region and for total Company, excluding the associated comparable online sales, as compared with the preceding year, is as follows:

                                                   13 Weeks Ended
                                            April 28,          April 30,
                                              2012                2011
           Gap North America                         4 %               (5 )%
           Old Navy North America                    2 %               (5 )%
           Banana Republic North America             4 %               (2 )%
           International                            (5 )%              (8 )%
           The Gap, Inc.                             2 %               (5 )%

Only Company-operated stores are included in the calculations of Comp sales. Gap and Banana Republic outlet Comp sales are reflected within the respective results of each brand. The results for Athleta are excluded from the calculations of total Company Comp sales due to its number of Comp stores compared to our other brands. The results for Piperlime are excluded from the calculations of total Company Comp sales, as Piperlime is an online-only brand.

A store is included in the Comp sales calculations when it has been open 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 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 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.

Comparable online sales include sales through online channels and are reported based on the location of the distribution center.

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:



                                                        13 Weeks Ended
                                                 April 28,         April 30,
                                                    2012             2011
         Net sales per average square foot (1)   $       81       $        76

(1) Excludes net sales associated with our online, catalog, and franchise businesses.

Store count, openings, closings, and square footage for our stores are as follows:

                                       January 28, 2012           13 Weeks Ended April 28, 2012                      April 28, 2012
                                          Number of            Number of                Number of            Number of           Square Footage
                                       Store Locations       Stores Opened            Stores Closed       Store Locations        (in millions)
Gap North America                                  1,043                  5                       26                 1,022                  10.5
Gap Europe                                           193                 -                         1                   192                   1.7
Gap Asia                                             152                 11                        2                   161                   1.6
Old Navy North America                             1,016                  6                        8                 1,014                  17.9
Banana Republic North America                        581                  6                        3                   584                   4.9
Banana Republic Asia                                  31                  3                        2                    32                   0.2
Banana Republic Europe                                10                 -                        -                     10                   0.1
Athleta North America                                 10                  1                       -                     11                    -

Company-operated stores total                      3,036                 32                       42                 3,026                  36.9
Franchise                                            227                 22                        5                   244                   N/A

Total                                              3,263                 54                       47                 3,270                  36.9

Increase (decrease) over prior year                                                                                    0.8 %                (2.4 )%

                                       January 29, 2011           13 Weeks Ended April 30, 2011                      April 30, 2011
                                          Number of            Number of                Number of            Number of           Square Footage
                                       Store Locations       Stores Opened            Stores Closed       Store Locations        (in millions)
Gap North America                                  1,111                  2                        9                 1,104                  11.1
Gap Europe                                           184                  3                        3                   184                   1.6
Gap Asia                                             135                  4                        1                   138                   1.3
Old Navy North America                             1,027                  6                       12                 1,021                  18.6
Banana Republic North America                        576                 -                        -                    576                   4.9
Banana Republic Asia                                  29                 -                         1                    28                   0.2
Banana Republic Europe                                 5                  2                       -                      7                   0.1
Athleta North America                                  1                 -                        -                      1                    -

Company-operated stores total                      3,068                 17                       26                 3,059                  37.8
Franchise                                            178                  8                       -                    186                   N/A

Total                                              3,246                 25                       26                 3,245                  37.8

Increase (decrease) over prior year                                                                                    0.4 %                (2.3 )%

Gap and Banana Republic outlet stores are reflected in each of the respective brands. We have franchise agreements with unaffiliated franchisees to operate Gap and Banana Republic stores throughout Asia, Australia, Eastern Europe, Latin America, the Middle East, and Africa.

In fiscal 2012, we expect to open about 160 new Company-operated store locations (about 130 net of repositions) and close about 145 Company-operated store locations (about 115 net of repositions). Through downsizes, we expect net square footage for Company-operated stores to decrease about 1 percent at the end of fiscal 2012 compared with the end of fiscal 2011. We expect our franchisees to open about 50 to 75 new franchise stores in fiscal 2012.

Net Sales

Our net sales for the first quarter of fiscal 2012 increased $192 million, or 6 percent, compared with the prior year comparable period due to an increase in net sales of $130 million related to our Stores reportable segment and an increase in net sales of $62 million related to our Direct reportable segment.

• For the Stores reportable segment, our net sales for the first quarter of fiscal 2012 increased $130 million, or 4 percent, compared with the prior year comparable period. The increase was primarily due to higher net sales across all brands and for franchise for the first quarter of fiscal 2012 compared with the prior year comparable period.

• For the Direct reportable segment, our net sales for the first quarter of fiscal 2012 increased $62 million, or 18 percent, compared with the prior year comparable period. The increase was due to the growth in our online business across all brands.

In the first quarter of fiscal 2012, our net sales for the U.S. and Canada (including Direct) were $3.0 billion, an increase of $135 million or 5 percent compared with $2.8 billion for the prior year comparable period. In the first quarter of fiscal 2012, our net sales outside of the U.S. and Canada (including Direct and franchise) were $511 million, an increase of $57 million or 13 percent compared with $454 million for the prior year comparable period.

Cost of Goods Sold and Occupancy Expenses



                                                                   13 Weeks Ended
                                                            April 28,          April 30,
($ in millions)                                               2012               2011
Cost of goods sold and occupancy expenses                  $     2,112        $     1,991
Gross profit                                               $     1,375        $     1,304
Cost of goods sold and occupancy expenses as a
percentage of net sales                                           60.6 %             60.4 %
Gross margin                                                      39.4 %             39.6 %

Cost of goods sold and occupancy expenses as a percentage of net sales increased 0.2 percent in the first quarter of fiscal 2012 compared with the prior year comparable period.

• Cost of goods sold increased 1.5 percent as a percentage of net sales in the first quarter of fiscal 2012 compared with the prior year comparable period. The increase in cost of goods sold as a percentage of net sales was primarily driven by increased cost of merchandise primarily due to higher cotton prices.

• Occupancy expenses decreased 1.3 percent as a percentage of net sales in the first quarter of fiscal 2012 compared with the prior year comparable period. The decrease in occupancy expenses as a percentage of net sales was primarily driven by higher net sales without a corresponding increase in occupancy expenses.

Operating Expenses



                                                            13 Weeks Ended
                                                      April 28,        April 30,
    ($ in millions)                                      2012            2011
    Operating expenses                                $      980      $       918
    Operating expenses as a percentage of net sales         28.1 %           27.9 %
    Operating margin                                        11.3 %           11.7 %

Operating expenses increased $62 million, or 0.2 percent as a percentage of net sales, in the first quarter of fiscal 2012 compared with the prior year comparable period. The increase in operating expenses was primarily due to higher marketing expenses, driven primarily by more investment in customer relationship marketing and Gap brand marketing, and higher store payroll expenses. Given our plans to invest prudently in growth initiatives and our domestic business, it is unlikely that we will leverage operating expenses for fiscal 2012.

For fiscal 2012, we expect operating margin to be about 10 percent.

Interest Expense

                                             13 Weeks Ended
                                      April 28,         April 30,
                   ($ in millions)       2012             2011
                   Interest expense   $       23       $         6

The increase in interest expense for the first quarter of fiscal 2012 compared with the prior year comparable period was primarily due to the incremental interest expense related to our $1.25 billion long-term debt, which was issued in April 2011, and $400 million term loan, which was funded in May 2011.

Income Taxes



                                             13 Weeks Ended
                                       April 28,        April 30,
                  ($ in millions)         2012            2011
                  Income taxes         $      140      $       148
                  Effective tax rate         37.5 %           38.8 %

The decrease in the effective tax rate for the first quarter of fiscal 2012 compared with the prior year comparable period was primarily due to favorable reassessments of tax positions during the first quarter of fiscal 2012.

We currently expect the fiscal 2012 effective tax rate to be about 39.5 percent. The actual rate will ultimately depend on several variables, including the mix of income between domestic and international operations, the overall level of income, the potential resolution of outstanding tax contingencies, and changes in tax laws and rates.

LIQUIDITY AND CAPITAL RESOURCES

Our largest source of operating 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.

As of April 28, 2012, cash and cash equivalents and short-term investments were $2.0 billion. As of April 28, 2012, the majority of our cash and cash equivalents was held in the U.S. and is generally accessible without any limitations. We believe that current cash balances and cash flows from our operations will be sufficient to support our business operations, including growth initiatives and planned capital expenditures, 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.

Cash Flows from Operating Activities

Net cash provided by operating activities during the first quarter of fiscal 2012 increased $133 million compared with the prior year comparable period, primarily due to the following:

• a decrease in merchandise inventory balances from the end of fiscal 2011 to the end of the first quarter of fiscal 2012 compared with an increase in merchandise inventory balances from the end of fiscal 2010 to the end of the first quarter of fiscal 2011; and

• a decrease in income tax payments in the first quarter of fiscal 2012 compared with the first quarter of fiscal 2011.

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 over a total of about eight weeks during the end-of-year holiday period. The seasonality of our operations may lead to . . .