UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.20549

FORM10-K 10-K

(Mark One)

Commission File Number 1-7562 

THE GAP, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:(650) 952-4400(415) 427-0100

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ   No ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨   No þ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ   No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ   No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨þ

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨   No þ

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of July 30, 201029, 2011 was approximately $9$7 billion based upon the last price reported for such date in the NYSE-Composite transactions.

The number of shares of the registrant’s common stock outstanding as of March 15, 201113, 2012 was 584,492,032.487,724,426.

Documents Incorporated by Reference

Portions of the registrant’s Proxy Statement for the Annual Meeting of Shareholders to be held on May 17, 201115, 2012 (hereinafter referred to as the “2011“2012 Proxy Statement”) are incorporated into Part III.

Special Note on Forward-looking Statements

This Annual Report on Form 10-K 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:

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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:

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Additional information regarding factors that could cause results to differ can be found in this Annual Report on Form 10-K and our other filings with the U.S. Securities and Exchange Commission.Commission (“SEC”).

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 March 28, 2011,26, 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.

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THE GAP, INC.

20102011 ANNUAL REPORT ON FORM10-K10-K

TABLE OF CONTENTS

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Part I

Item 1. 1. Business.

General

The Gap, Inc. (the(Gap Inc., the “Company,” “we,” and “our”) was incorporated in the State of California in July 1969 and was reincorporated under the laws of the State of Delaware in May 1988.

We areGap Inc. is a leading global specialty retailer offeringapparel 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. Our global portfolio of distinct brands crosses multiple channels and geographies, which gives us a compelling business proposition and a competitive advantage in the retail marketplace.

Gap Inc. has 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 throughout Asia, Australia, Eastern Europe, Latin America, the Middle East, and Africa. Under these agreements, third parties operate or will operate stores that sell apparel and related products under our brand names. We have more than tripled our franchise store base from the end of fiscal 2007 to 227 stores at the end of fiscal 2011. Our products are also available to customers online in over 90 countries through company-owned websites and using a U.S.-based third party that provides 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 have Company-operated stores in the United States, Canada, the United Kingdom, France, Ireland, Japan, and beginning in November 2010, 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.

Gap.  Gap products are sold in three channels: full price retail stores, online, and outlet.  Founded in 1969, Gap stores offer an extensive selectionis our flagship brand and remains one of classically styled, high quality,the most iconic apparel brands in the marketplace today. The brand stands for casual, apparelAmerican style – at moderateaccessible price points. Products range from wardrobe basics such as denim, khakis, and T-shirts to fashionAssortments include well-designed apparel accessories, and personal care products for men and women.women, including denim, khakis, outerwear, tees, and accessories. In 1986, weaddition to designing its own merchandise, Gap offers limited “capsule” collections in partnership with some of the fashion industry’s best-loved designers and other third-party merchandise from time to time.

Gap entered the children’s apparel market in 1986 with the introduction of GapKids and in 1989 we establishedwith babyGap. These stores offer casualMaternity apparel and accessories inwas later added to the tradition of Gap style and quality for children ages newborn through pre-teen. We also offer maternity apparel.collection. In 1998, we launched GapBody, offering women’s underwear,which offers loungewear, sleepwear, loungewear, and sportsintimates, and active apparel. We operateapparel for women. Today, Gap Outletproducts are available globally in our specialty and outlet stores, which carry similar categories of products at lower price points. In 1997, we introduced Gap Online, an online, store found at gap.com. Gap Online offers products comparable to those carriedand in Gap, GapKids, babyGap, and GapBody stores, as well as extended sizes not found infranchise stores. Beginning in 2010, customers in Canada can shop online at gapcanada.ca, customers in the United Kingdom and select European countries can shop online at gap.eu, customers in China can shop online at gap.cn, and customers in select international countries can shop online at gap.com.

Banana Republic.  Banana Republic products are sold in three channels: full price retail stores, online,is a global, multi-channel brand that is a destination for modern, versatile work wear for both men and outlet. women.

Acquired in 1983 with two stores, Banana Republic offers sophisticated, fashionablehas evolved to offer collections of casual and tailoredthat include apparel, handbags, shoes, accessories, andjewelry, personal care products, and eyewear for men and women at higher price points than Gap. We operateGap brand. Today, customers can purchase Banana Republic Factory Stores, which carry similar categories of products at lower price points. In 1999, we introduced Banana Republic Online, anin our specialty and outlet stores, online, store found at bananarepublic.com, which offers products comparable to those carriedand in the store collections, as well as extended sizes not found infranchise stores. Beginning in 2010, customers in Canada can shop online at bananarepublic.ca, customers in the United Kingdom and select European countries can shop online at bananarepublic.eu, and customers in select international countries can shop online at bananarepublic.com.

Old Navy.  Old Navy products are soldopened its first store in two channels: full price retail stores1994, offering customers great product at great prices. The brand targets young families, with a focus on providing a fun shopping environment and online. We launchedvalue-priced apparel. Today, Old Navy in 1994continues to address the market for value-priced family apparel. Old Navy offers broadoffer on-trend selections of value-priced apparel, shoes, and accessories for adults, children, and babies, as well as other items, including a maternity line consumables, and personal care products. In 2000, we establishedconsumables. Customers can purchase Old Navy Online, an online store found at oldnavy.com. Old Navy Online offers apparel and accessories comparable to those carriedproducts in stores in the store collections, as wellU.S. and Canada and online, which includes online-exclusive items such as a plus size line not found in stores. Beginning in 2010, customers in Canada can shop online at oldnavy.ca and customers in select international countries can shop online at oldnavy.com.plus-size line.

Piperlime.  InLaunched in 2006, we launched Piperlime is an online-only store found at piperlime.com. Piperlimeonline fashion boutique. The brand offers customers an assortmenta fresh and unique mix of theprivate label and leading brands in footwear, handbags, apparel, and jewelryaccessories for women and footwear for men, and kids, as well as footwear for kids. Customers will also find exclusive advice, tips, trends, and advicetrends from leading style authorities. Beginning in 2010, customers in select international countries can shop online at piperlime.com.experts.

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Athleta.  Athleta products are sold in two channels: full price retail stores and online.  Acquired in September 2008, Athleta is Gap Inc.’s newest brand. Athleta offers customers high quality and performance-driven women’s sports and active apparel and footwear that is stylish and functional for a variety of activities, including golf, running, skiing, and snowboarding, tennis, swimming, and yoga. In May 2010, we opened a test store in Mill Valley, California, and in January 2011, we opened a flagship store in San Francisco, California. Customersaddition to Athleta’s high-quality products, customers can purchase Athleta product, as well as an assortment of products from leading brands in women’s active-wear,active wear. Customers can purchase Athleta products online, at athleta.com, through thea catalog, orand beginning in 2010, in our stores. Beginning in 2010, customers in select international countries can shop online at athleta.com.

All sales are tendered for cash, personal checks, debit cards, or credit cards. We also issue and redeem gift cards through our brands. Gap, Banana Republic, and Old Navy each have a private label credit card program and a co-branded credit card program through which frequent customers receive benefits. Private label and co-branded credit cards are provided by a third-party financing company.

Our stores offer a shopper-friendly environment with an assortment of casual apparel and accessories that emphasize style, quality, and good value. The range of merchandise displayed in each store varies depending on the selling season and the size and location of the store. Stores are generally open seven days per week (where permitted by law) and most holidays.

We ended fiscal year 20102011 with 3,2463,263 Company-operated and franchise store locations. For more information on the number of stores by brand and region, see the table in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included asin Part II, Item 7 of this Form 10-K.

During fiscal 2011, we operated two reportable segments: Stores and Direct.

Certain financial information about our reportable segments and international operations is set forth under the heading “Segment Information” in Note 1415 of Notes to Consolidated Financial Statements included in Part II, Item 8 of this Form 10-K.

Merchandise Vendors

We purchase private label merchandise from approximately 590 vendors and non-private label merchandise from approximately 430over 1,000 vendors. Our vendors have facilities in approximately 5043 countries. No vendor accounted for more than 34 percent of the dollar amount of our total fiscal 20102011 purchases. Of our merchandise sold during fiscal 2010,2011, approximately 198 percent of all units (representing approximately 2 percent of total cost) were produced domestically, while the remaining 99 percent of all units (representing approximately 98 percent of total cost) were produced outside the United States.States, while the remaining 2 percent of all units were produced domestically. Approximately 2726 percent of our merchandise units (representing approximately 30 percent of total cost) were produced in China. Product cost increases or events causing disruption of imports from China or other foreign countries, including the imposition of additional import restrictions or vendors potentially failing due to political, financial, or regulatory issues, could have an adverse effect on our operations. Substantially all of our foreign purchases of merchandise are negotiated and paid for in U.S. dollars. Also see the sections entitled “Risk Factors—Trade matters may disrupt our supply chain” and “Risk Factors—Our Products are subject to risks associated with global sourcing and manufacturing, including increased product costs” and “Risk Factors—Trade matters may disrupt our supply chain” in Item 1A of this Form 10-K.

Seasonal Business

Our business follows a seasonal pattern, with sales peaking over a total of about eight weeks during the end-of-year holiday period.

Brand Building

Our ability to develop and evolve our existing brands is key to our success. We believe our distinct brands are among our most important assets. With the exception of Piperlime, virtually all aspects of brand development, from product design and distribution to marketing, merchandising and shopping environments, are controlled by Gap Inc. employees. With respect to Piperlime, we control all aspects of brand development except for product design related to third-party products. We continue to invest in our brands and enhance the customer experience through the remodeling of existing stores, the opening of new stores, the closure of under-performing stores, international expansion, thesignificant investments in marketing, enhancement of our online shopping sites, additional investments in marketing,international expansion, remodeling of existing stores, and continued focus on customer service.

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Trademarks and Service Marks

Gap, GapKids, babyGap, GapBody, Banana Republic, Old Navy, Piperlime, and Athleta trademarks and service marks, and certain other trademarks, have been registered, or are the subject of pending trademark applications, with the United States Patent and Trademark Office and with the registries of many foreign countries and/or are protected by common law.

Franchising

We have franchise agreements with unaffiliated franchisees to operate Gap and/or Banana Republic stores in a number of countries, including Australia, Bahrain, Bulgaria, Chile, Colombia, Croatia, Cyprus, Egypt, Greece, Guam, Indonesia, Israel, Jordan, Kazakhstan, Kuwait, Lebanon, Malaysia, Mexico, Morocco, Oman, Panama, Peru, Philippines, Poland, Qatar, Romania, Russia, Saudi Arabia, Serbia, Singapore, South Korea, Thailand, Turkey, andUkraine, United Arab Emirates.Emirates, Uruguay, and Vietnam. Under these agreements, third parties operate, or will operate, stores that sell apparel and related products under our brand names. We continue to increase the number of countries in which we enter into these types of arrangements as part of our effortsstrategy to expand internationally. For additional information on risks related to our franchise business, see the sectionsections entitled “Risk Factors—Our efforts to expand internationally may not be successfulsuccessful” and “Risk Factors—Our franchise business is subject to certain risks not directly within our control and could impair the value of our brands” in Item 1A of this Form 10-K.

Inventory

The cyclical nature of the retail business requires us to carry a significant amount of inventory, especially prior to peak selling seasons when we, along with other retailers, generally build up inventory levels. We maintain a large part of our inventory in distribution centers. We review our inventory levels in order to identify slow-moving merchandise and broken assortments (items no longer in stock in a sufficient range of sizes)sizes or colors) and use markdowns to clear merchandise. As we do not carry much replenishment inventory in our stores, much of our inventory is maintained in distribution centers. Also see the section entitled “Risk Factors—We must successfully gauge fashion trends and changing consumer preferences to succeed” in Item 1A of this Form 10-K.

Competitors

The global specialty apparel retail industry is highly competitive. We compete with local, national, and global department stores, specialty and discount store chains, independent retail stores, and online businesses that market similar lines of merchandise.apparel retailers. We are also faced with competition in European, Japanese, Chinese, and Canadian markets from established regional and national chains, and our franchisees face significant competition in the markets in which they operate. Also see the section entitled “Risk Factors—Our business is highly competitive” in Item 1A of this Form 10-K.

Employees

As of January 29, 2011,28, 2012, we had a work force of approximately 134,000132,000 employees, which includes a combination of part- and full-time employees. We also hire seasonal employees, primarily during the peak end-of-year holiday period.

To remain competitive in the apparel retail industry, we must attract, develop, and retain skilled employees, including executives. Competition for such personnel is intense. Our success is dependent to a significant degree on the continued contributions of key employees. Also see the section entitled “Risk Factors—We must successfully gauge fashionapparel trends and changing consumer preferences to succeed” in Item 1A of this Form 10-K.

Available Information

We make available on our website, gapinc.com, under “Investors, Financial Information, SEC Filings,” free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports as soon as reasonably practicable after we electronically file or furnish them to the U.S. Securities and Exchange Commission (“SEC”).SEC.

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Our Board of Directors Committee Charters (Audit and Finance, Compensation and Management Development, and Governance and Nominating Committees), and Corporate Governance Guidelines are also available on our website under “Investors, Governance.” The Code of Business Conduct can be found at gapinc.com under “Investors, Corporate Compliance, Code of Business Conduct.” Any amendments and waivers to the code will also be available on the website.

Executive Officers of the Registrant

The following are our executive officers:

Name, Age, Position, and Principal Occupation:

Michelle Banks, 47,48, Executive Vice President, General Counsel, Corporate Secretary, and Chief Compliance Officer since March 2011; Senior Vice President, General Counsel, Corporate Secretary, and Chief Compliance Officer from March 2008 to March 2011; Senior Vice President and General Counsel from November 2006 to March 2008; Vice President from March 2005 to November 2006; Associate General Counsel from February 2003 to March 2005; Senior Corporate Counsel from January 1999 to February 2003.

Colin Funnell, 50, Executive Vice President, Global Supply Chain since September 2011; Senior Vice President, Supply Chain Strategy, Strategic Sourcing, and Global Logistics from June 2010 to August 2011; Senior Vice President, Corporate Operations and Logistics from 2008 to June 2010; Senior Vice President, Logistics from 2006 to 2007; Senior Vice President, Global Production and Old Navy Supply Chain from 2004 to 2005.

John T. (Tom) Keiser, 45,46, Executive Vice President and Chief Information Officer since January 2010; Executive Vice President and Chief Information Officer of The Limited Brands, Inc., an apparel company, from 2006 to October 2009; Senior Vice President, INSIGHT Program of The Limited Brands, Inc. from 2004 to 2006.

Glenn Murphy, 49,50, Chairman and Chief Executive Officer since August 2007; Chief Executive Officer of Shoppers Drug Mart Corporation, a drug store chain, from 2001 to 2007.

Art Peck, 55,56, President, Gap North America since February 2011; Executive Vice President of Strategy and Operations from May 2005 to February 2011; President, Gap Inc. Outlet from October 2008 to February 2011; Acting President, Gap Inc. Outlet from February 2008 to October 2008; Senior Vice President of The Boston Consulting Group, a business consulting firm, from 1982 to May 2005.

Stanley P. Raggio, 54, Executive Vice President, Global Supply Chain since March 2010; Senior Vice President, Gap International Sourcing from March 2006 to March 2010; Retired from 2002 to 2006; Senior Vice President, International Sourcing & Logistics from 1995 to 2002; Vice President, International Logistics from 1990 to 1995.

Eva Sage-Gavin, 52,53, Executive Vice President, Global Human Resources and Corporate Affairs since February 2010; Executive Vice President, Human Resources, Communications and Global Responsibility from April 2008 to February 2010; Executive Vice President, Human Resources and Communications from February 2007 to April 2008; Executive Vice President, Human Resources from March 2003 to February 2007.

Sabrina Simmons, 47,48, Executive Vice President and Chief Financial Officer since January 2008; Executive Vice President, Corporate Finance from September 2007 to January 2008; Senior Vice President, Corporate Finance and Treasurer from March 2003 to September 2007; Vice President and Treasurer from September 2001 to March 2003.

J. Tom Wyatt, 55, President, Old Navy since August 2008; Acting President, Old Navy from February 2008 to August 2008; President, Gap Inc. Outlet from February 2007 to February 2008; President, GapBody from March 2006 to February 2007.

Item 1A.1A. Risk Factors.

Our past performance may not be a reliable indicator of future performance because actual future results and trends may differ materially depending on a variety of factors, including but not limited to the risks and uncertainties discussed below. In addition, historical trends should not be used to anticipate results or trends in future periods.

GeneralGlobal economic conditions and the impact on consumer spending patterns could adversely impact our results of operations.

The Company’s performance is subject to generalglobal economic conditions and their impact on levels of consumer spending.spending worldwide. Some of the factors influencing consumer spending include fluctuating interest rates and credit availability, fluctuating fuel and other energy costs, fluctuating commodity prices, higher levels of unemployment, higher consumer debt levels, reductions in net worth based on market declines and uncertainty, home foreclosures and reductions in home values, fluctuating interest rates and credit availability, government austerity measures, fluctuating fuel and other energy costs, fluctuating commodity prices, and general uncertainty regarding the overall future economic environment. Consumer purchases of discretionary items, including our merchandise, generally decline during periods when disposable income is adversely affected or there is economic uncertainty,uncertainty.

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Adverse changes in the global economy, or in any of the regions in which we sell our products, could reduce consumer confidence, and such conditionsthereby could adversely impactnegatively affect earnings and have a material adverse effect on our results of operations. For example, the global financial economic downturn that began in 2008 and continued throughout 2011, particularly in Europe, has negatively impacted consumer confidence. In a challenging and uncertain economic environment, we cannot predict whether or when such circumstances may improve or worsen, or what impact, if any, such circumstances could have on our business, results of operations, cash flows, and financial position.

Our business is highly competitive.

The global specialty apparel retail industry is highly competitive. We compete with local, national, and global department stores, specialty and discount store chains, independent retail stores, and online businesses that market similar lines of merchandise. We face a variety of competitive challenges including:

In addition, our franchisees face significant competition in the markets in which they operate. If we or our franchisees are not able to compete successfully in the United States or internationally, our results of operations could be adversely affected.

We must successfully gauge fashionapparel trends and changing consumer preferences to succeed.

Our success is largely dependent upon our ability to gauge the fashion tastes of our customers and to provide merchandise that satisfies customer demand in a timely manner. However, lead times for many of our purchases are long, which may make it more difficult for us to respond rapidly to new or changing fashion trends or consumer acceptance of our products. In addition, the competitive landscape requires that more merchandise be produced through faster pipeline channels. The global specialty retail business fluctuates according to changes in consumer preferences, dictated in part by fashion and season. To the extent we misjudge the market for our merchandise or the products suitable for local markets or fail to execute trends and deliver product to market as timely as our competitors, our sales will be adversely affected, and the markdowns required to move the resulting excess inventory will adversely affect our operating results. Some of our past product offerings have not been well received by our broad and diverse customer base. Merchandise misjudgments could have a material adverse effect on our operating results.

Our ability to anticipate and effectively respond to changing fashion trends depends in part on our ability to attract and retain key personnel in our design, merchandising, marketing, and other functions. Competition for this personnel is intense, and we cannot be sure that we will be able to attract and retain a sufficient number of qualified personnel in future periods.

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Fluctuations in the global specialty retail business especially affect the inventory owned by apparel retailers, as merchandise usually must be ordered well in advance of the season and frequently before fashion trends are evidenced by customer purchases. In addition, the cyclical nature of the global specialty retail business requires us to carry a significant amount of inventory, especially prior to the peak holiday selling season when we build up our inventory levels. We must enter into contracts for the purchase and manufacture of merchandise well in advance

of the applicable selling season. As a result, we are vulnerable to demand and pricing shifts and to suboptimal selection and timing of merchandise purchases. In the past, we have not always predicted our customers’ preferences and acceptance levels of our fashion items with accuracy. If sales do not meet expectations, too much inventory may cause excessive markdowns, and therefore, lower than planned margins.

Our products arebusiness, including our costs and supply chain, is subject to risks associated with global sourcing and manufacturing, including increased product costs.manufacturing.

Independent third parties manufacture nearly all of our products for us. As a result, we are directly impacted by increases in the cost of those products.For example, cotton prices have risenrose substantially since the beginning ofduring fiscal 2010, and we expect them to continue to rise in fiscal 2011. The current increases in commodity prices, specifically cotton, may2011, which put significant pressure on our average unit costs and may impact our gross margins.

If we experience significant increases in demand or need to replace an existing vendor, there can be no assurance that additional manufacturing capacity will be available when required on terms that are acceptable to us or that any vendor would allocate sufficient capacity to us in order to meet our requirements. In addition, for any new manufacturing source, we may encounter delays in production and added costs as a result of the time it takes to train our vendors in our methods, products, quality control standards, and environmental, labor, health, and safety standards. Moreover, in the event of a significant disruption in the supply of the fabrics or raw materials used by our vendors in the manufacture of our products, our vendors might not be able to locate alternative suppliers of materials of comparable quality at an acceptable price. Any delays, interruption, or increased costs in the manufacture of our products could result in lower sales and net income.

Because independent vendors manufacture nearly all of our products outside of our principal sales markets, third parties must transport our products over large geographic distances. Delays in the shipment or delivery of our products due to the availability of transportation, work stoppages, port strikes, infrastructure congestion, or other factors, and costs and delays associated with transitioning between vendors, could adversely impact our financial performance. Manufacturing delays or unexpected demand for our products may require us to use faster, but more expensive, transportation methods such as aircraft, which could adversely affect our gross margins. In addition, the cost of fuel is a significant component in transportation costs, so increases in the price of petroleum products can adversely affect our gross margins.

Our efforts to expand internationally may not be successful and could impair the value of our brands.successful.

Our current strategies include international expansion in a number of countries around the world through a number of channels and brands.brands, including franchise. For example, we currently plan to open Old Navy stores outside of North America, open additional Gap stores in Europe and China, expand Banana Republic in Europe, open additional international outlet stores, in Canada, Europe, and Asia, andcontinue to grow online sales internationally. We have limited experience operating in a numbersome of these countries.locations. In many of these countries,locations, we face major, established competitors. In addition, in many of these countries,locations, the real estate, employment and labor, transportation and logistics, regulatory, and other operating requirements differ dramatically from those in the places where we have experience. Moreover, consumer tastes and trends may differ in many of these countries,locations, and as a result, the sales of our products may not be successful or result in the margins we anticipate. If our international expansion plans are unsuccessful or do not deliver an appropriate return on our investments, our operations and financial results could be materially, adversely affected.

Our franchise business is subject to certain risks not directly within our control and could impair the value of our brands.

We also have entered into franchise agreements with unaffiliated franchisees to operate stores in many countries around the world. Under these agreements, third parties operate, or will operate, stores that sell apparel and related products under our brand names. However, prior to fiscal 2006, we had no experience operating through these types of third-party arrangements, and we can provide no assurance that these arrangements will be successful. The effect of these arrangements on our business and results of operations is uncertain and will

depend upon various factors, including the demand for our products in new markets internationally and our ability to successfully identify appropriate third parties to act as franchisees, distributors, or in a similar capacity. In addition, certain aspects of these arrangements are not directly within our control, such as the ability of these third parties to meet their projections regarding store locations, store openings, and sales. Other risks that may affect these third parties include general economic conditions in specific countries or markets, foreign exchange, changes in diplomatic and trade relationships, and political instability. Moreover,

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while the agreements we have entered into and plan to enter into in the future provide us with certain termination rights, the value of our brands could be impaired to the extent that these third parties do not operate their stores in a manner consistent with our requirements regarding our brand identities and customer experience standards. Failure to protect the value of our brands, or any other harmful acts or omissions by a franchisee, could have an adverse effect on our results of operations and our reputation.

The market for prime real estate is competitive.

Our ability to effectively obtain real estate to open new stores nationally and internationally depends on the availability of real estate that meets our criteria for traffic, square footage, co-tenancies, lease economics, demographics, and other factors, including our ability to negotiate terms that meet our financial targets.factors. We also must be able to effectively renew our existing store leases. In addition, in recent years, we have been seeking to downsize, consolidate, reposition, or close some of our real estate locations, which in most cases requires a modification of an existing store lease. Failure to secure adequate new locations or successfully modify existing locations, or failure to effectively manage the profitability of our existing fleet of stores, could have a material adverse effect on our results of operations.

Additionally, the current economic environment may at times make it difficult to determine the fair market rent of retail real estate properties within the United States and internationally. This could impact the quality of our decisions to exercise lease options at previously negotiated rents and the quality of our decisions to renew expiring leases at negotiated rents. Any adverse effect on the quality of these decisions could impact our ability to retain real estate locations adequate to meet our targets or efficiently manage the profitability of our existing fleet of stores and could have a material adverse effect on our results of operations.

We experience fluctuations in our comparable store sales and margins.

Our success depends in part on our ability to improve sales, in particular at our largest brands. A variety of factors affect comparable store sales, including fashion trends, competition, current economic conditions, the timing of new merchandise releases and promotional events, changes in our merchandise mix, the success of marketing programs, and weather conditions. These factors may cause our comparable store sales results to differ materially from prior periods and from expectations. Our comparable storesales, including the associated comparable online sales, have fluctuated significantly in the past on an annual, quarterly, and monthly basis as demonstrated bybasis. Over the past 24 months, our reported monthly comparable sales have ranged from an increase of 11 percent in March 2010 to a decrease of 1210 percent in fiscal 2008, a decrease of 3 percent in fiscal 2009, and an increase of 1 percent in fiscal 2010.March 2011. Over the past five years, our reported gross margins have ranged from a high of 4040.3 percent in fiscal 2009 to a low of 3636.1 percent in fiscal 2006.2007. In addition, over the past five years, our reported operating margins have ranged from a high of 1313.4 percent in fiscal 2010 to a low of 88.3 percent in fiscal 2006.2007.

Our ability to deliver strong comparable store sales results and margins depends in large part on accurately forecasting demand and fashion trends, selecting effective marketing techniques, providing an appropriate mix of merchandise for our broad and diverse customer base, managing inventory effectively, using effective pricing strategies, and optimizing store performance. Failure to meet the expectations of investors, securities analysts, or credit rating agencies in one or more future periods could reduce the market price of our common stock and cause our credit ratings to decline.

Changes in our credit profile or deterioration in market conditions may limit our access to the capital markets.markets and adversely impact our financial results and our ability to service our debt.

AlthoughIn the first quarter of fiscal 2011, given favorable market conditions and our history of generating consistent and strong operating cash flow, we believe our existingmade the strategic decision to issue debt. In April 2011, we issued $1.25 billion aggregate principal amount of 5.95 percent notes due April 12, 2021. We also entered into a $400 million five-year term loan due April 2016, which was funded in May 2011. As a result, we have additional costs that include interest payable semiannually on the notes and at least quarterly on the term loan. We also have repayments due annually for the term loan.

Our cash flows from operations are the primary source of funds for these debt service payments. In this regard, we have generated annual cash flow from operations in excess of $1 billion per year for the past decade and ended fiscal 2011 with $1.9 billion of cash and cash equivalents combinedon our balance sheet. We are also able to supplement near-term liquidity, if necessary, with futureour $500 million revolving credit facility. We continue to target a cash flowbalance of

$1.2 billion which provides not only for our working capital needs, but also a reserve for unexpected business downturns. However, if our cash flows from our operations will be adequate to satisfy our business operations needs for the foreseeable future,decline significantly, we may require additional cash for unexpected contingencies.

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There can be no assurance thatunable to service or refinance our current levels of liquidity will continue or thatdebt while maintaining our abilityother business initiatives. In addition, the interest rate on our term loan is subject to accessadjustment from time to time with the credit or capital markets will not be adversely affected by changes in the financial markets and the global economy.

Any future reduction inLondon Interbank Offered Rate plus a margin based on our long-term senior unsecured credit ratingratings from Moody’s Investors Service and Standard & Poor’s Rating Service. Any future reduction in these ratings would increase our interest costs related to our term loan and could result in reduced access to the credit and capital markets and higher interest costs on future financings.

As of January 29, 2011,We remain committed to maintaining a strong financial profile with ample liquidity. Proceeds from the Company had $1.7 billion in cash and cash equivalents and short-term investments.debt issuance were used for general corporate purposes including share repurchases.

For further information on our debt and credit facilities, see the section entitled “Credit Facilities” in our “Management’s DiscussionItem 8, Financial Statements and AnalysisSupplementary Data, Notes 4 and 5 of Notes to Consolidated Financial Condition and Results of Operations” included as Part II, Item 7Statements of this Form 10-K.

Trade matters may disrupt our supply chain.

Trade restrictions, including increased tariffs or quotas, embargoes, safeguards, and customs restrictions against apparel items, as well as U.S. or foreign labor strikes, work stoppages, or boycotts, could increase the cost or reduce the supply of apparel available to us and adversely affect our business, financial condition, and results of operations. We cannot predict whether any of the countries in which our merchandise currently is manufactured or may be manufactured in the future will be subject to additional trade restrictions imposed by the U.S. and other foreign governments, including the likelihood, type, or effect of any such restrictions. In addition, we face the possibility of anti-dumping or countervailing duties lawsuits from U.S. domestic producers. We are unable to determine the impact of the changes to the quota system or the impact that potential tariff lawsuits could have on our global sourcing operations. Our sourcing operations may be adversely affected by trade limits or political and financial instability, resulting in the disruption of trade from exporting countries, significant fluctuation in the value of the U.S. dollar against foreign currencies, restrictions on the transfer of funds, and/or other trade disruptions.

Updates or changes to our IT systems may disrupt operations.

We continue to evaluate and implement upgrades and changes to our IT systems.systems, some of which are significant. Upgrades involve replacing existing systems with successor systems, making changes to existing systems, or cost-effectively acquiring new systems with new functionality. We are aware of inherent risks associated with replacing these systems, including accurately capturing data and system disruptions, and believe we are taking appropriate action to mitigate the risks through testing, training, and staging implementation, as well as ensuring appropriate commercial contracts are in place with third-party vendors supplying such replacement technologies.or supporting our IT initiatives. However, there can be no assurances that we will successfully launch these systems as planned or that they will occur without disruptions to our operations. IT system disruptions, if not anticipated and appropriately mitigated, or failure to successfully implement new or upgraded systems, could have a material adverse effect on our results of operations.

Our IT services agreement with IBM could cause disruptions in our operations and have an adverse effect on our financial results.

We have entered into the sixthseventh year of a ten-year non-exclusive services agreement with International Business Machines Corporation (“IBM”) under which IBM operates certain significant aspects of our IT infrastructure. Under the original agreement, this included supporting our mainframe, server, network and data center, and store operations, as well as help desk, end user support, and some disaster recovery. TheSince the original agreement wasin January 2006, we have amended effective March 2, 2009the agreement to return to ustake back certain services originally performed by IBM under the agreement.IBM. These returned services include services related to management of our server and data center environment, along with disaster recovery.recovery, circuit expense billing, database administration services, and help desk services for stores worldwide. All other services remain with IBM per the original agreement. Our ability to realize the expected benefits of this arrangement is subject to various risks, some of which are not within our complete control. These risks include, but are not limited to, disruption in services and the failure to protect the security and integrity of the Company’s data under the terms of the agreement. We are unable to provide assurances that some or all of these risks will not occur. Failure to effectively mitigate these risks, if they occur, could have a material adverse effect on our operations and financial results.

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We are subject to cybersecurity risks and may incur increasing costs in an effort to minimize those risks.

Our business employs systems and websites that allow for the secure storage and transmission of proprietary or confidential information regarding our customers, employees, job applicants, and others, including credit card information and personal identification information. Security breaches could expose us to a risk of loss or misuse of this information, litigation, and potential liability. We may not have the resources or technical sophistication to anticipate or prevent rapidly-evolving types of cyber attacks. Attacks may be targeted at us, our customers, or others who have entrusted us with information. Actual or anticipated attacks may cause us to incur increasing costs, including costs to deploy additional personnel and protection technologies, train employees, and engage third-party experts and consultants. Advances in computer capabilities, new technological discoveries, or other developments may result in the technology used by us to protect transaction or other data being breached or compromised. In addition, data and security breaches can also occur as a result of non-technical issues, including breach by us or by persons with whom we have commercial relationships that result in the unauthorized release of personal or confidential information. Any compromise or breach of our security could result in a violation of applicable privacy and other laws, significant legal and financial exposure, and a loss of confidence in our security measures, which could have an adverse effect on our results of operations and our reputation.

Our results could be adversely affected by natural disasters, public health crises, political crises, or other catastrophic events.

Natural disasters, such as hurricanes, tornadoes, floods, earthquakes, and other adverse weather and climate conditions; unforeseen public health crises, such as pandemics and epidemics; political crises, such as terrorist attacks, war, and other political instability; or other catastrophic events, whether occurring in the United States or internationally, could disrupt our operations, the operations of our franchisees, or the operations of one or more of our vendors. In particular, these types of events could impact our product supply chain from or to the impacted region and could impact our ability or the ability of our franchisees or other third parties to operate our stores or websites. In addition, these types of events could negatively impact consumer spending in the impacted regions or depending upon the severity, globally. For example, our fiscal 2011 operations and financial results were adversely affected by the March 2011 earthquake and related tsunami and nuclear disaster in Japan, which caused damage to our stores and reduced consumer spending in Japan. To the extent any of these events occur, our operations and financial results could be materially, adversely affected.

Failure of our vendors to adhere to our code of vendor conduct could harm our business.

We purchase nearly all merchandise from third-party vendors outside of the United States and require those vendors to adhere to a code of vendor conduct and other environmental, labor, health, and safety standards for the benefit of workers. From time to time, contractors may not be in compliance with these standards or applicable local laws. Significant or continuing noncompliance with such standards and laws by one or more contractors could have a negative impact on our reputation and an adverse effect on our results of operations.

Changes in the regulatory or administrative landscape could adversely affect our financial condition and results of operations.

Laws and regulations at the local, state, federal, and international levels frequently change, and the ultimate cost of compliance cannot be precisely estimated. In addition, we cannot predict the impact that may result from changes in the regulatory or administrative landscape. Any changes in regulations, the imposition of additional regulations, or the enactment of any new or more stringent legislation that impacts employment and labor, trade, product safety, transportation and logistics, health care, tax, privacy, operations, or environmental issues, among others, could have an adverse impact on our financial condition and results of operations.

Item 1B.1B. Unresolved Staff Comments.

None.

Item 2.2. Properties.

We have Company-operated stores in the United States, Canada, the United Kingdom, France, Ireland, Japan, China, and Italy. As of January 29, 2011,28, 2012, the Company-operated stores aggregated approximately 38.237.2 million square feet. Almost all of these stores are leased, with one or more renewal options after our initial term, or have slightly longer terms with negotiated termination clauses at predetermined sales thresholds.term. Economic terms vary by type of location.

We own approximately 1.2 million square feet of corporate office space located in San Francisco, San Bruno, and Rocklin, California, of which approximately 184,000448,000 square feet is leased to and occupied by another company and approximately 264,000 square feet is leased to but not yet surrendered to another company.others. We lease approximately 1.11.2 million square feet of corporate office space located in San Francisco, San Bruno, Rocklin, Petaluma, and Petaluma,Los Angeles, California; New York, New York; Albuquerque, New Mexico; and Toronto, Ontario, Canada. Of the 1.11.2 million square feet of leased office space, approximately 230,000 square feet is under sublease to others and approximately 15,000 square feet is unoccupied and not being marketed for sublease to others. We also lease 139 regional offices in North America and approximately 3027 international offices. We own approximately 8.6 million square feet of distribution space located in Fresno, California; Fishkill, New York; Groveport, Ohio; Gallatin, Tennessee; Brampton, Ontario, Canada; and Rugby, England. We lease approximately 2.4 million square feet of distribution space located in Phoenix, Arizona; Grove City, Ohio; Northern Kentucky; Bolton, Ontario, Canada; and Stafford, England. Of the 2.4 million square feet of leased distribution space, 100,000 square feet is under sublease to others. Two separate third-party logistics companies provide logistics services to us through a 459,000 square foot distribution warehouse in Chiba, Japan, which we are in the process of relocating to a 375,000 square foot distribution warehouse in Chiba, Japan, and a 43,000 square foot distribution warehouse in Shanghai, China.

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Item 3.3. Legal Proceedings.

As a multinational company, we are subject to various proceedings, lawsuits, disputes, and claims (“Actions”) arising in the ordinary course of our business. Many of these Actions raise complex factual and legal issues and are subject to uncertainties. Actions filed against us from time to time include commercial, intellectual property, customer, employment, data privacy, and securities relatedsecurities-related claims, including class action lawsuits. The plaintiffs in some Actions seek unspecified damages or injunctive relief, or both. Actions are in various procedural stages, and some are covered in part by insurance.

We cannot predict with assurance the outcome of Actions brought against us. Accordingly, adverse developments, settlements, or resolutions may occur and negatively impact income in the quarter of such development, settlement, or resolution. However, we do not believe that the outcome of any current Action would have a material adverse effect on our financial results.

Item 4. Removed and Reserved. Mine Safety Disclosures.

Not applicable.

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Part II

Item 5.5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

The principal market on which our stock is traded is the New York Stock Exchange. The number of holders of record of our stock as of March 15, 201113, 2012 was 8,644.8,396. The table below sets forth the market prices and dividends declared and paid for each of the fiscal quarters in fiscal 20102011 and fiscal 2009.2010.

Stock Performance Graph

The graph below compares the percentage changes in our cumulative total stockholder return on our common stock for the five-year period ended January 29, 2011,28, 2012, with (i) the cumulative total return of the Dow Jones U.S. Retail Apparel Index and (ii) the S&P 500 Index. The total stockholder return for our common stock assumes quarterly reinvestment of dividends.

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Total Return Analysis

Source: Research Data Group, Inc. (415) 643-6000 (www.researchdatagroup.com/S&P.htm)(www.researchdatagroup.com)

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

The following table presents information with respect to purchases of common stock of the Company made during the thirteen weeks ended January 29, 201128, 2012 by The Gap, Inc. or any affiliated purchaser, as defined in Exchange Act Rule 10b-18(a)(3):

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\

Item 6. Selected Financial Data.

The following selected financial data are derived from the Consolidated Financial Statements of the Company. We have also included certain non-financial data to enhance your understanding of our business. In fiscal 2007, we closed our Forth & Towne stores, and accordingly, loss per share from the resultsoperations of Forth & Towne havehas been presented as a discontinued operation in the table below. The data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 and the Company’s Consolidated Financial Statements and related notes in Item 8.

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18       GAP INC. FORM 10-K

Item 7.7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Overview

We are a global specialty retailer offering 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, and beginning in November 2010, 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. In addition, our products are available to customers online in over 90 countries. 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.

Financial highlightsFiscal 2011 was a challenging year. Unemployment remained high in our core North America markets and the apparel retail environment was quite promotional. The debt crisis in Europe increased stock market volatility globally, and the earthquake and tsunami in Japan had a negative impact on our business in Asia. Our largest expense, cost of goods sold, escalated sharply in fiscal 2011 primarily as a result of global cotton price inflation, putting significant pressure on our margins, especially in the second half of fiscal 2011. Finally, we had product challenges throughout fiscal 2011 in our domestic and international businesses. As a result, earnings for fiscal 2010 include2011 were below last year. Despite these challenges, we are pleased with the following:progress we made against our long-term strategic plan, including growing our online business and expanding internationally. We also continued to reduce our square footage in North America through closures and consolidations at Gap and downsizes at Old Navy. We managed our operating expenses carefully. We delivered higher average selling price per unit throughout the year, enabled by our disciplined inventory management. We generated $815 million of free cash flow and distributed $2.3 billion to shareholders through dividends and share repurchases. 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 Liquidity and Capital Resources section.

Financial results for fiscal 2011 are as follows:

Our business and financial priorities for fiscal 20112012 are as follows:

As we focus on growing revenues in our more mature North America marketstabilizing comparable store sales in fiscal 2011,2012, we also plan to continue growinggrow revenues internationally through the following:

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Results of Operations

Net Sales

Net sales primarily consist of retail sales, online sales, and wholesale and franchise revenues, and shipping fees received from customers for delivery of merchandise.revenues.

See Item 8, Financial Statements and Supplementary Data, Note 1415 of Notes to Consolidated Financial Statements for net sales by brand, region, and reportable segment.

Comparable Store Sales

Beginning in fiscal 2011, the Company reports comparable (“Comp”) sales including the associated comparable online sales. Accordingly, Comp sales for fiscal 2010 have been recalculated to conform to fiscal 2011 presentation.

The percentage change in comparable store (“Comp”)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:

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:

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Only the Company-operated stores are included in the calculationcalculations of Comp sales. The Comp sales calculation excludes sales from our online and catalog businesses and wholesale and franchise businesses. 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 12 monthsone calendar 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. Current year foreign exchange rates are applied to both current year and prior year Comp sales to achieve a consistent basis for comparison.

A store is considered non-comparable (“Non-comp”) when it has been open for less than 12 monthsone calendar 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.

Beginning in fiscal 2011, the Company reports comparable sales including the associated comparable online sales. Online comparableComp sales are defined as sales through online channels in regionscountries where we have existing comparableComp store sales. The Company’s comparable

Current year foreign exchange rates are applied to both current year and prior year Comp sales including the associated comparable online sales increased 2 percentto achieve a consistent basis for fiscal 2010.comparison.

Store Count and Square Footage Information

Net sales per average square foot is as follows:

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

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

WeIn fiscal 2012, net of repositions, we expect to open about 115125 new Company-operated store locations and close about 125115 Company-operated store locations in fiscal 2011. As a result of theselocations. Through downsizes and net store closures, and through downsizes, we expect net square footage for Company-operated stores to decrease about 31 percent for fiscal 2011.2012. As a result of ongoing strategic closures and consolidations at Gap brand, we expect to have a total of about 950 Gap stores in North America by the end of fiscal 2013. We also expect our franchisees to open about 7550 new franchise stores in fiscal 2011.2012.

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Net Sales Discussion

Our net sales for fiscal 2011 decreased $115 million, or 1 percent, compared with fiscal 2010 due to a decrease in net sales of $376 million related to our Stores reportable segment, partially offset by an increase in net sales of $261 million related to our Direct reportable segment.

In fiscal 2011, our net sales, including Direct, for the U.S. and Canada were $12.4 billion, a decrease of $353 million or 3 percent compared with $12.7 billion for fiscal 2010. In fiscal 2011, our net sales, including Direct, outside of the U.S. and Canada were $2.2 billion, an increase of $238 million or 12 percent compared with $1.9 billion for fiscal 2010.

Our net sales for fiscal 2010 increased $467 million, or 3 percent, compared with fiscal 2009 due to an increase in net sales of $286 million related to our Stores reportable segment and an increase in net sales of $181 million related to our Direct reportable segment.

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OurIn fiscal 2010, our net sales, including Direct, for fiscal 2009 decreased $329the U.S. and Canada were $12.7 billion, an increase of $259 million or 2 percent compared with $12.5 billion for fiscal 2008 due to a decrease in net sales of $417 million related to our Stores reportable segment, partially offset by an increase in net sales of $88 million related to our Direct reportable segment.

Cost of Goods Sold and Occupancy Expenses

Cost of goods sold and occupancy expenses as a percentage of net sales increased 4.0 percent in fiscal 2011 compared with fiscal 2010.

Cost of goods sold and occupancy expenses as a percentage of net sales increased 0.1 percentage pointspercent in fiscal 2010 compared with fiscal 2009.

Cost of goods sold and occupancy expenses as a percentage of net sales decreased 2.8 percentage points in fiscal 2009 compared with fiscal 2008.Operating Expenses

Operating Expenses

Operating expenses increased $12 million, but decreased 0.8 percentage pointspercent as a percentage of net sales, in fiscal 2010 compared with fiscal 2009. The increase in operating expenses was mainlyprimarily due to higher store payroll, store benefits, and other store-related expenses and higher expenses due to our New York and San Francisco headquarter office moves, partially offset by a decrease in bonus expense.

Operating expenses increased $10 million, or 0.7 percentage points as a percentage of net sales, in fiscal 2009 compared with fiscal 2008. The increase was mainly due to increased marketing expenses primarily for Gap and Old Navy, offset by decreased store payroll and benefits and other store-related expenses.

Interest Expense (Reversal)

Interest expense for fiscal 2011 primarily consists of 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.

Interest expense for fiscal 2010 includes an interest expense reversal of $15 million from the reduction of interest expense accruals resulting primarily from the filing of a U.S. federal income tax accounting method change application and the resolution of the IRS’sInternal Revenue Service’s review of the Company’s federal income tax returns and refund claims for fiscal 2001 through 2006.

Interest expense for fiscal 2008 includes an interest expense reversal of $9 million from the reduction of interest expense accruals resulting primarily from foreign tax audit events occurring in the period.

The decrease in interest expense, net of interest expense reversal, for fiscal 2009 compared with fiscal 2008 was primarily due to the maturities of our $138 million, 8.80 percent notes repaid in December 2008 and $50 million, 6.25 percent notes repaid in March 2009.

Interest Income

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Interest income is earned on our cash and cash equivalents and investments. The decrease in interest income for fiscal 2011 compared with fiscal 2010 was primarily due to a lower monthly average cash and cash equivalents and investments balance during fiscal 2011.

The decrease in interest income for fiscal 2010 compared with fiscal 2009 was primarily due to a lower monthly average cash balancesand cash equivalents and investments balance during fiscal 2010.

Interest income decreased for fiscal 2009 compared with fiscal 2008 primarily due to lower interest rates.

Income Taxes

While the effective tax rate for fiscal 2011 decreased slightly compared with fiscal 2010, there were changes in individual components of the effective tax rate. State and other income taxes decreased primarily due to changes in state tax laws and increases in state and federal tax credits. The decreases in these components were offset by the tax impact of foreign operations, which increased primarily due to operating losses in China and Hong Kong for fiscal 2011 (for which no tax benefit has been provided), and their greater impact due to lower Gap Inc. pre-tax income for fiscal 2011, as well as the unfavorable impact of a change in the mix of income between domestic and foreign operations.

Although the effective tax rate for fiscal 2010 remained unchanged from fiscal 2009, there were changes in individual components of the effective tax rate. The tax impact of foreign operations increased primarily due to the recording of valuation allowances related to losses incurred by our China subsidiaries and incremental tax expense

24       GAP INC. FORM 10-K

related to the repatriation of earnings from our Canadian subsidiaries. The increase was primarily offset by the release of unrecognized tax benefits for closed years.

The increase in the effective tax rate for fiscal 2009 compared with fiscal 2008 was primarily driven by providing U.S. taxes on certain foreign earnings, the impact of changes in state tax laws, and a change in the mix of income between domestic and international operations.

We currently expect the fiscal 20112012 effective tax rate to be about 3939.5 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, payment of taxes, and share repurchases. In addition to share repurchases, we also continue to return cash to our shareholders in the form of dividends.

In the first quarter of fiscal 2011, we made the strategic decision to issue debt in the aggregate amount of $1.65 billion. Given favorable market conditions and our history of generating consistent and strong operating cash flow, we took this step to provide a more optimal capital structure. The Company has generated annual cash flow from operations in excess of $1 billion per year for the past decade and ended fiscal 2011 with $1.9 billion of cash and cash equivalents. We remain committed to maintaining a strong financial profile with ample liquidity.

We consider the following to be measures of our liquidity and capital resources:

Our working capital and current ratio asAs of January 29, 2011 decreased compared with January 30, 2010, primarily due to decreases in28, 2012, the majority of our cash and cash equivalents was held in the U.S. and short-term investments. See Cash Flows discussed below.is generally accessible without any limitations.

As of January 29, 2011, cash and cash equivalents and short-term investments were $1.7 billion. Our operating cash flow generation and cash position remain strong.

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 existing $500 million revolving credit facility.

Cash Flows from Operating Activities

Net cash provided by operating activities during fiscal 2011 decreased $381 million compared with fiscal 2010, primarily due to the following:

Net cash provided by operating activities during fiscal 2010 decreased $184 million compared with fiscal 2009, primarily due to the following:

Net cash provided by operating activities during fiscal 2009 increased $516 million compared with fiscal 2008, primarily due to the following:

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 significant fluctuations in certain asset and liability accounts between fiscal year-end and subsequent interim periods.

Cash Flows from Investing Activities

Our cash outflows fromfor investing activities are primarily for capital expenditures and purchases of investments, while cash inflows are primarily proceeds from maturities of investments. Net cash used for investing activities during fiscal 2011 increased $25 million compared with fiscal 2010, primarily due to the following:

Net cash used for investing activities during fiscal 2010 decreased $108 million compared with fiscal 2009, primarily due to the following:

Net cash used for investing activities duringIn fiscal 2009 increased $139 million compared with fiscal 2008, primarily due to the following:

2011, capital expenditures were $548 million. For fiscal 2011,2012, we expect capital expenditures to be about $575$600 million.

Cash Flows from Financing Activities

Our cash outflows from financing activities consist primarily of the repurchases of our common stock and dividend payments. Cash inflows primarily consist of proceeds from share-based compensation, netthe issuance of withholding tax payments. long-term debt. Net cash used for financing activities during fiscal 2011 decreased $1.5 billion compared with fiscal 2010, primarily due to the following:

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Net cash used for financing activities during fiscal 2010 increased $1.4 billion compared with fiscal 2009, primarily due to the following:

Net cash used for financing activities during fiscal 2009 decreased $234 million compared with fiscal 2008, primarily due to the following:

Free Cash Flow

Free cash flow is a non-GAAP financial measure. We believe free cash flow is an important metric because it represents a measure of how much cash a company has available for discretionary and non-discretionary items after the deduction of capital expenditures, as we require regular capital expenditures to build and maintain stores and purchase new equipment to improve our business. We use this metric internally, as we believe our sustained ability to generate free cash flow is an important driver of value creation. However, this non-GAAP financial measure is not intended to supersede or replace our GAAP results.result.

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The following table reconciles free cash flow, a non-GAAP financial measure, from a GAAP financial measure.