Gymboree Thinks Smaller, Gets Bigger

When Lisa Harper became Gymboree Corp.’s general merchandise manager in February 2000, she stopped the children’s clothing retailer from trying to make tots look like miniature teenagers.

Kids should look like kids, Harper decided, and muted colors like olive green went out the window. Trendy pieces like two-tone baseball shirts and sparkly tank tops went too, replaced by colorful tops, bottoms and accessories that could be mixed and matched.

It wasn’t a novel idea. Classic, easy-to-coordinate clothes defined Gymboree in the early and mid-1990s and caused profit to more than double during its first five years as a public company. What worked then, worked again. After Harper’s first complete line hit stores in October 2000, Gymboree had its first sales gain in five quarters.

After two years of losses, Gymboree expects to earn 12 cents to 14 cents a share in the year ending Feb. 2. Still, the turnaround is far from over, investors and analysts said. Harper, who was promoted to chief executive in February, has fixed the fashions. Now, she needs to increase sales, keep inventory lean and sell more clothing at full price to prop up profit margins, investors said.

“I’m looking for continued margin expansion,” said Jeff Matthews, managing partner of Ram Partners. “That’s going to translate into higher earnings.” Ram Partners, a private hedge fund, owns Gymboree shares.

The shares have almost doubled in the last six months, as the Burlingame, Calif.-based company boosted sales and profit forecasts. The stock trades at more than 100 times estimated earnings for this fiscal year, compared with a multiple of 29% for the Standard & Poor’s Retail Stores Composite Index.

Gymboree’s multiple isn’t unusual for a company in the early stages of a comeback, analysts said. Profit is forecast to more than triple in fiscal 2003 to 47 cents a share, according to Thomson Financial/First Call, and that would bring Gymboree’s ratio in line with the index, analysts said.

The company has spent the last year studying sales trends at its 581 stores and crunching numbers. In fiscal 2003, the company will use what it’s learned to send each store the right amount for its size and sales volume, the right styles for its customers and the right sleeve lengths for its climate, Harper, 42, said.

This “micromerchandising,” a first for Gymboree, is expected to increase sales and lead to fewer price cuts when implemented in the second half of next year, Harper said. That will mean wider profit margins, or more money made on each item sold.

Margins began deteriorating in fiscal 1999, when Gymboree opened more than 120 stores. The stores were various sizes and shapes, in various types of malls, serving various types of markets, and they all got the same stuff.

Gross profit narrowed that year to 36% of sales from 44% a year earlier, and profit fell for the first time since Gymboree’s initial public offering in 1993.

“We didn’t adjust our operational strategies to that new group of stores,” said Harper, who doesn’t have children. “We’ve never really gotten a return on those stores.”

Harper’s goal next year is to halve the “too-wide” margin gap between Gymboree’s lowest-volume and highest-volume stores.

Last quarter, she pushed the newest offerings to the front of stores, and gross profit widened to 36% of sales from 32% as shoppers bought more full-price clothing.

This quarter, Gymboree increased the coordinated collections it sells to 16 a year from 12, and trimmed the number of pieces in each. Delivering smaller lines more often fuels demand and leaves fewer items to mark down, Harper said. Inventory at the start of fiscal 2003 will be 8% to 12% leaner than a year earlier, she said.

Harper earned $313,462 in fiscal 2001 as president and chief operating officer and got a bonus of $25,020, according to a proxy filing. Gymboree declined to provide more recent information.

The president revived “Matchmatics,” a selling approach Gymboree used in the mid-1990s.

In-store displays, trained salespeople and the Gymboree Web site coach customers in outfit-building. A shopper buying pants and a top is encouraged to get coordinating socks or a sweater. Customers spent an average 12% more during each visit last quarter, largely because of Matchmatics, Gymboree said.

Harper designed clothes for Gymboree from 1992 to 1995 before being lured to clothing maker Esprit. By the time she returned in January 1999, the selling concept had been abandoned as management chased the latest trends.

She may have a hard time persuading consumers to spend more when many are looking to stretch their budgets in the recession, some investors said.

“With unemployment rising-- and this is a little higher-ticket, a little better-quality merchandise-- you can be concerned about the near term,” said portfolio manager Buzz Zaino of Royce & Associates. Royce, which began buying Gymboree shares in 2000, sold the last of its stake in November.

Even if Matchmatics catches on, it won’t bring back the good old days, investors said. In the early 1990s, Gymboree competed mostly with department stores. Now, the $25-billion-a-year U.S. children’s clothing market is crowded with rivals such as Gap Inc.’s BabyGap, Children’s Place Retail Stores Inc., and low-price chains such as Target Corp. and Kohl’s Corp.

“You have a lot more stores now doing the same thing that Gymboree is doing, so that keeps the lid on pricing,” said Sean McLeod, who manages about 120,000 Gymboree shares for the Marshall Small-Cap Growth Fund.

In fiscal 1995, sales were about $875 a square foot, Harper said. Gymboree is aiming for $500 this fiscal year, up from $425 last year.

And next year?

“Somewhere between $500 and $875,” Harper said.