Gymboree (NASDAQ:GYMB) sure knows how to ruin what would have been a nifty earnings report. Street-beating earnings of $1.00 per share yesterday were overshadowed by guidance for the first quarter that can only be described as frightening. Predictions for first-quarter comps were down 20%-25%, margins dropped as much as 800 basis points, and continued misery through the second quarter had one analyst on the conference calling this Gymboree's "Armageddon."
It's the economy, right?
No, actually. Gymboree attributes at least half of its predicted woes to some federal safety regulations that seemingly caught the company by surprise. On the heels of the lead toy scare in 2007, other children's items came under scrutiny. Eventually apparel was targeted, and Gymboree had to respond by testing, either in-house or through third parties, about 25,000 different styles across more than 800 stores.
When some of those garments tested positive for lead, Gymboree pulled them from the shelves. Only later did federal authorities clarify that many of those items would be exempt from the regulation because the offending lead on the garment was inaccessible and therefore posed no threat of lead exposure.
A similar situation arose with new regulations on phthalates, chemicals used in many flexible plastics and screen prints. After initially believing that the phthalate regulations would not affect existing inventory, Gymboree later learned that the regulations would be applied retroactively, forcing it to remove the offending products.
Yes, we have no sleepwear
The upshot of this was a lot of empty shelves at your local Gymboree during February, and given the company's nine- to 12-month cycle time on its products, the hit to inventory is going to hurt results for a while. This may even ripple all the way through to the third and fourth quarters. Management is spinning it as its commitment to safety and an extra-cautious interpretation of the regulations, but a cynic might say it was caught with its (lead-buckled) pants down and had to eviscerate inventories to reach compliance on time.
The worst is over, right?
The story doesn't end there. Lead regulations are being tightened again in August. Gymboree asserts that quality control has been beefed up and a similar situation won't arise again, barring any shenanigans from the regulators. Investors who watch too many congressional hearings are going to want to know how much management knew and when it knew it.
I think the more important question coming out of this is who else is going to surprise us with horror stories about these regulations. While megastores Wal-Mart (NYSE:WMT) and Target (NYSE:TGT) would see relatively little impact, retailers like Gap (NYSE:GPS) that focus on apparel and feature kid-specific lines and stores could have similar issues.
But if Gymboree nemesis The Children's Place (NASDAQ:PLCE) seems unfazed when it reports in two weeks, the folks at Gymboree might need a good spanking. The stock has already taken one.
Some Foolish reminiscing:
- Remember the lead toy scare?
- Gymboree used to deliver the goods.
- Is Children's Place a better bet?
