For Gap Inc, this year is turning out to be a year for living dangerously.
Just two years ago, Gap seemed unstoppable. Its stores sprouted brazenly in every mall and on every city street corner, and its president and chief executive, Millard Drexler, was lionized as a merchandising prince. And when Gap commanded its customers to wear leather, they obeyed.
PHOTO: NY TIMES
Now the chain, based in San Francisco, is no longer the arbiter of Everyman style, and Drexler, once thought infallible, is under the microscope as never before. Even measured by the ruthlessly dizzying cycles of fashion-world cool, Gap's fall from grace has been swift. Sales in stores open at least a year began declining in April 2000, and the slide has not stopped.
The financial fallout has been grim: operating margins have evaporated into almost nothing, from 9 percent a year ago, and the company is expected to have a loss of US$22 million this year, after a profit of US$877 million last year.
This month, the top credit agencies reduced the company's ratings several levels, to junk status.
Gap's stock, which hit a high of US$53.75 in February 2000, closed at US$12.41 on Friday.
Drexler has responded to this staggering disintegration with a drumbeat of promises to improve fashions and win back the over-30 crowd -- whom Gap had alienated with hip offerings like crocheted halter tops and jeans-style jackets in orchid-colored leather.
"Our challenge in the current market is to find the right balance between key items and fashion from both an assortment and presentation standpoint," he said in August. "This is our No. 1 priority."
Drexler's brilliance as a merchant has saved Gap before. The chain was slumping in 1995 and 1996 when he sensed the move toward casual business dress and cashed in heavily on khakis.
But this time is different. Gap, which also owns the Banana Republic and Old Navy chains and operates a total of about 4,200 stores, has far more constraints now. For starters, its total debt is around US$2 billion, up from just US$21 million in 1995. As recently as late 1998, Gap had more cash than debt; the debt now exceeds cash by US$1.2 billion.
With so precarious a position, Gap's survival game must rely on more than Drexler's intuition about the perfect denim skirt or knee-length knit sweater.
On Tuesday, when Gap releases its annual financial report, many analysts are hoping for signs of drastic action at last.
"They have to be looking for a major restructuring plan," said Carol Levenson, research director at Gimme Credit, an investor newsletter in Chicago. "At some point you've got to cut costs more dramatically, and you can't just wait to get back into the fashion rhythm."
The crucial issue for Gap, as it was for Kmart, which sought bankruptcy protection in January, is generating enough cash flow to service its debt. In November 2000, an important measure of Gap's financial viability -- the ratio of earnings (before interest, taxes, depreciation and amortization) to interest payments -- stood at 7.3. By the third quarter of last year, that ratio had slipped to 4.7, according to Standard & Poor's.
"We think it is going a lot lower," said Gerald Hirschberg, a director for corporate ratings at Standard & Poor's. "A ratio of 4 or 5 still provides a pretty good margin, but we have been concerned with the steep decline."
Analysts are comfortable that for now, Gap has the liquidity to cover its debt. But the coming months will be most important. If the chain still has not regained its fashion touch by Christmas, it could face a nightmare. Another disastrous season would make it taxingly expensive to raise cash just as US$500 million in debt matures in 2003.
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