Description

The company has a market capitalization of $371 million and no debt with $65 million in cash. Assuming moderate margin improvement in 2005 on somewhat higher sales, the company is trading at a low double digits EPS multiple excluding the net cash on the balance sheet.

GYMB is a specialty retailer operating stores selling high quality apparel and accessories, as well as play programs, for women and children under the Gymboree, Janie and Jack, Janeville, Gymboree Play & Music brands.

As of October 30, 2004, there are 643 stores, including 615 stores in the United States and 28 stores in Canada. The plan for the remainder of fiscal 2004 is to continue to grow our domestic store base for Gymboree, Janie and Jack and Janeville, bringing the total number of store openings for fiscal 2004 to approximately 24, 23 and 14 new stores, respectively.

The company has four divisions: Gymboree, Janie and Jack, Janeville and Gymboree Play & Music.

Gymboree: Gymboree retail stores offer high quality, fashionable, child-appropriate apparel and accessories characterized by bright colors, patterns and whimsical graphics, complex embellishments, comfort, functionality, and durability for children ages newborn to 9 years.

Janie and Jack: Janie and Jack is a new specialty retail concept launched in the third quarter of 2002. The Janie and Jack shops are highly differentiated from the Gymboree stores. Janie and Jack shops offer distinctive, finely crafted clothing and accessories for boys and girls sizes preemie to 3T. Lush fabrics, a hand-made quality and details such as hand-embroidery, smocking and vintage prints are utilized to create classic looks. Shops have an old mercantile boutique style with special details such as wainscotting and distressed wooden armoires.

Janeville: Janeville is the Company’s newest specialty retail concept. Janeville offers trend-infused apparel and accessories for women in their mid-30s and older. Clothing is modern, fresh and comfortable, designed with high quality fabrics and flattering cuts and styling. Janeville stores feature a residential environment with a cottage façade, front porch, and french doors. Subtle feminine details are found throughout the store, such as slip-covered furniture, one-of-a-kind fixtures, found objects, distressed wood and contrasting, warm textures

Gymboree Play & Music: Gymboree Play & Music offers directed parent-child developmental play programs designed to enhance early childhood development through fun-filled sensory and motor activities that engage children ages newborn to 5 years old through sight, touch, sound and movement. Gymboree Play & Music also offers art classes and birthday party services and sells certain developmentally appropriate toys and audiotapes.

The stock currently sells for $11.97, off 35% from its 52 week high reached in May. The company has made some merchandising mistakes and is facing pricing issues that are largely self-inflicted. Comps were particularly weak in November, down 10% against management’s expectations of a 5% drop. Management still expects flat comps in 4Q, which implies positive comps in December and January driven by event promotions and discounting.

One area of concern is that management will take the discounting too far and sacrifice profitability in the process. However, the company still retains a strong brand and a lot of financial strength that should enable it to fix its current problems.

Note that GYMB earned operating margins of 6.5% in 2002 and 7.0% in 2003. Although this year margins are only expected to be 4.7%, management has four major initiatives to recalibrate the business in 2005: lower product costs, reduce seasonality, improve merchandising in the boys business, and simplify collections. It is not unreasonable to assume that the company can return closer to its historical margin results in 2005. A 6% operating margin on $695mm in revenue would produce EPS of roughly $0.85 per share in 2005. Longer term, GYMB could be capable of achieving low double digit operating margins through gross margin expansion and SG&A leverage. Indeed, the Janie and Jack and Janeville should ultimately produce higher operating margins than the core Gymboree business, perhaps in the mid-teens neighborhood.

At 14x 2005 estimates, GYMB trades below its historical average. Moreover, cash on the balance sheet of $64.6mm represents 17% of the market cap – and the company will end the year with even more cash on hand following the seasonally strong 4Q. Stripping out the cash as of the end of 3Q, the company trades at only 11-12x forward earnings.

Management is led by CEO Lisa Harper and SVP of Merchandising for Kids, Kip Garcia. The company also recently hired Blair Lambert as its new COO, filling an important role. In 2004, GYMB plans to open 55-60 new stores, including about 20 for Gymboree, 25 for Janie and Jack, and 14 Janeville stores.

Overall, the risk/reward on GYMB shares looks attractive from current levels.

Risks
1. continued aggressive discounting
2. fashion risk, particularly in the boys business
3. increasingly competitive entrants into the business

Catalyst

Catalysts
1. successful implementation of 2005 initiatives
2. recent hiring of a new COO, Blair Lambert, who will begin in January 2005
3. upswing in same store sales in December and January