Refocusing Gap

Analysts look for results as S.F. retailer implements turnaround plan

George Raine, Chronicle Staff Writer��� Sunday, November 25, 2001

Most of us fret over the sartorial choices we make daily: Will it be the Duke of Wellington's Regiment rep tie or Gurkha Brigade stripe? The Cole Haan pumps or Kenneth Cole boots?Imagine the stress at Gap Inc., the nation's largest specialty apparel retailer, where managers decided months ago which clothes would be lining store shelves this holiday shopping season. Gap customers, shareholders and employees hope they bet right.

Even in an industry as fickle as the retailing trade, many of Gap's merchandising picks -- beginning in 1969 when Donald and Doris Fisher opened their first store -- were right on target, often inspiring. Since then, the San Francisco company has spawned many imitators.

Gap has a market capitalization of $13.1 billion, is 40 percent bigger than its closest rival, the Limited, has 166,000 full- and part-time employees, including 4,000 in the Bay Area, and operates 4,147 stores in the United States, United Kingdom, Canada, Japan, France and Germany.But has the company lost its winning hand? For 18 consecutive months, Gap has reported that same-store sales posted a year-over-year decline. Same-store sales, a key industry barometer, represent sales at stores open at least one year.

Gap Inc., owner of Gap, Banana Republic, Old Navy, GapKids, BabyGap and GapBody stores, had a net loss of $179 million for the third fiscal quarter that ended Nov. 3, its first quarterly loss in 10 years. The company, which dismissed 1,040 employees and eliminated an additional 560 unfilled positions at its headquarters operations in July, has seen its stock price drop sharply this year. Gap shares closed at $15.19 on Friday, compared with $25.50 at the end of December.

Gap's stock price lost 44.6 percent of its value in calendar 2000.The company's shareholders are not used to being on a downward slide. Gap's stock price jumped by 23.1 percent in calendar 1999 and by 138 percent in calendar 1998. (Gap's fiscal year ends in February).Gap's top managers, who through a company spokeswoman declined interview requests, say they have a handle on the company's problems and are taking steps to correct them.

Indeed, there was a polished calmness in the voices of corporate officers during a teleconference with analysts earlier this month, as well as assurances that the company is being refocused and that a turnaround is near."There were lots of lessons learned from the fall season," said Heidi Kunz, Gap's executive vice president and chief financial officer. "We got way too narrow in the way we were addressing customer needs."

"We're reviewing budgets for next year and I assure you there is a good deal of attention on expense management around here," said John Lillie, a Gap director since 1992 who joined the company full time in January in the newly created role of vice chairman.Lillie has the executive resume Gap President and Chief Executive Officer Millard "Mickey" Drexler believes can help reverse the company's slide. Lillie previously served as president of Sequoia Associates, a leveraged buyout firm in Menlo Park; chairman and CEO of American President Cos., a large shipping concern; and chairman and CEO of Lucky Stores, a grocery chain.

"I think our relationship has been superb," Lillie said of working with Drexler. "We both understand very clearly who does what well."Wall Street has great respect for Drexler, the merchant Don Fisher hired as Gap division president in 1983, who became Gap Inc. CEO in 1995. Analysts appreciate his candor.

"Who are you going to call to replace him?" asked Richard Jaffe, an analyst with UBS Warburg in New York. "There's not a plethora of talent. There's not a farm team of great merchants coming up. Just the opposite. There's a real lack of talent. The question of who is best equipped to fix Gap always comes back to Mickey," he said.

"Mickey Drexler is a brilliant merchant," said Elizabeth Pierce, an analyst with Wedbush Morgan Securities in Los Angeles. "But I believe he has a lot on his plate, and whenever you get as big as this you are going to lose your nimbleness to respond quickly."

Drexler was blunt when he spoke at a Goldman Sachs conference in September."We changed too much, we changed too quickly in ways that weren't consistent with our brand, we tampered with our formulas too much and we lost consistency. We got sloppy and had too many cooks in the kitchen," he said.

This has been Gap's challenge. There was a memory lapse about who its core customer is, and a flirtation with fashion that wasn't Gap. Time and money were wasted on poor choices like miniskirts, ultra-low-rise jeans, and turquoise, orange and green leather jackets and pants. Like other bad bets, they were quickly relegated to the discount table.Mistakes can be costly. Gap reported a $27 million after-tax charge for canceled product orders in the third quarter.

Analysts criticize Gap's size, saying the company remains fixed on a growth plan that no longer makes sense given the decline in comparable-store sales. Some say the company's stores steal business from each other."Something that costs $38 at Gap sells for $20 at Old Navy," said Louis E.V.

Nevaer, an economist and writer who spent two years researching Gap for his book, "Into -- and Out of -- the Gap: A Cautionary Account of an American Retailer," published in September. "So you can get Gap clothes with an Old Navy logo."

The company says it remains committed to growth and plans to expand by about 5 percent in fiscal 2002, a company spokeswoman said. Plans call for about 150 new Gap stores, 20 or 30 more Banana Republic stores and about 80 additional Old Navy units, the spokeswoman said.Some analysts remain unconvinced by that strategy. They also say Gap must do a better job of defining its product mix and differentiating its main brands: Gap, Banana Republic and Old Navy."We believe that this poor earnings performance is far from over," said Jennifer Black of Wells Fargo Van Kasper in Portland, Ore. "In our opinion, the company needs to clearly define its target customer for each of its brands as well as reduce its real-estate portfolio before it can begin to return to its former glory," she said.

Said UBS Warburg's Jaffee: "The key merchandising efforts include broadening the appeal of Old Navy's offerings, adjusting the balance between undated basics and wearable fashion offerings at Gap stores, and making Banana Republic less elitist in price, fit and fashionability and therefore more accessible."Despite Gap's effectiveness in managing this business, it all comes down to the product."Gap is not the only retailer with problems. Many have seen a big drop in business, especially during the past 18 months amid the general economic downturn and the stock market's volatility. The Sept. 11 terrorist attacks also affected consumer confidence.

But because of Gap's size and trendsetting reputation, analysts will be closely watching its performance this critical holiday shopping season."They were once riding high, and all the other retailers were left in the ditch scratching their heads wondering what to do," said Kurt Barnard of Barnard's Retail Report in Upper Montclair, N.J. "But the others woke up and did the same thing the Gap did, some of them better and cheaper."

Barnard added: "Every time for at least the last three years they tried to be innovative with fashion they fell flat on their faces. Mickey Drexler should have an answer. Everybody is waiting. Shareholders are waiting. The public is waiting."

Drexler articulated his game plan during the company's teleconference with analysts early this month."To restore our comparable-store sales and earnings performance, we're tightly managing our business and focusing on the fundamentals," he said."Our priorities are controlling costs, strengthening margins and getting the product right for our customers."

Pierce, the Wedbush Morgan Securities analyst, said she spends considerable time mingling with shoppers -- she did an eight-city, eight-day "mall crawl" earlier this year -- and reports Gap stores were surprisingly crowded."The problem was (customers) were drawn to the promotional activity. There is a lot of brand equity at Gap Inc., but customers are not buying as much and will not until they get the merchandise back on track," she said.

Business was brisk at the flagship Banana Republic on Grant Avenue near San Francisco's Union Square last Wednesday, and 25-year-old Sean Reimer of Sacramento was in his element."Banana Republic is my favorite place," said Reimer, who works for Volt Services Group, a large staffing company.

"This stuff is very contemporary. They're on the cutting edge of styles for each season," said Reimer, who estimates he spends $2,000 a year at Banana Republic."They have marketed so well to my group, mid-20s, that we don't have to worry about being out of style," Reimer said."But I just walk past Gap stores. Too many pastels."