Another Industry Turnaround Continues; Abercrombie & Fitch’s Quarter

It was last December when A&F’s long time CEO was “resigned” by its board of directors. I posted a link last winter to an article about how that came to happen. Here’s that link.

That’s not to say he had complete responsibility for what went wrong at A&F. But, as the article made clear, it’s fair to say that his presence and management style delayed A&F acknowledging and dealing with its issues.

They are still looking for a new CEO. I agree with them when they say they want to do it right- not fast.

Sales in the quarter ended August 1 fell 8.2% to $818 million from $891 million in the same quarter last year. Abercrombie sales were down 9.5% from $421 to $381 million. Hollister fell 5.9% from $465 to $437 million. In the U.S., revenues fell 5.9% from$546 to $515 million. Europe, due partly to a strengthening dollar, fell 19.3% from $248 to $200 million. What they call “other” was up from $96 to $103 million, or by 7.4%.

“The decrease in net sales was largely attributable to the adverse effect of changes in foreign currency exchange rates (based on converting prior year sales at current year exchange rates) of approximately $45 million and a 4% decrease in comparable sales, partially offset by the net impact of store openings, closings and remodels.”

Comparable store sales were down 4% compared to 7% in last year’s quarter. Hollister brand comparable store sales were down 1% compared to 10% in last year’s quarter. Abercrombie went from a comparable store decline of 1% in last year’s quarter to 7% this year.

Alert! In an itsy, bitsy footnote, we are told these calculations are done in constant currency. The comparison would be way worse without this adjustment as 37% of revenues came from outside the U.S.

A&F ended the quarter with a total of 954 stores. 783 were in the U.S. and 171 outside it. That’s down from 989 stores a year ago. During the year they expect to close 60 stores in the U.S., open 10 outlet stores and 6 full price stores in North America. 15 full price stores will be opened in “…key international growth markets…”

The gross margin rose very slightly from 62.1% to 62.3%. I want to remind you that in the first quarter of fiscal 2015 (ended April 30) A&F “…recognized a $26.9 million charge to write-down the carrying value of inventory to net realizable value…” In the quarter ended August 1, 2015, they determined that they had taken too big a write down for that inventory and recaptured $2.62 million of that write-down. That was responsible for half the increase in gross margin.

Store and distribution expense fell 8.7% from $426 to $389 million. As a percentage of sales, it was down 0.3%. “The increase was primarily due to the deleveraging effect of negative comparable sales, partially offset by expense reduction efforts.”

Marketing, general and administrative expense rose 7.9% from $111 to $120 million. As a percentage of sales, they rose by 2.2%. However, “The increase was primarily due to $15.8 million of legal settlement charges and the deleveraging effect of negative comparable sales, partially offset by expense reduction efforts.”

Operating income fell from $19.5 to $2 million. Interest expense more than doubled from $2 to $4.6 million reducing pretax income from a profit of $17.5 million to a loss of $2.6 million. There was a tax benefit of $3.2 million compared tax expense of $4.6 million in last year’s quarter. Net income declined from $12.9 million to $612,000.

On the balance sheet, we see a minor improvement in the current ratio from 1.93 to 2.08. But that’s happened because a year ago current liabilities included borrowings of $75 million. In this year’s quarter, that’s down to $2 million.

Cash is up from $311 to $408 million and inventory has fallen by 13% to $479 million. Remember the $26.9 inventory write down that accounts for a chunk of that decline. Accounts payable rose 24.4% from $180 to $199 million. And accrued expense was up 7.8% from $278 to $299 million. Long term borrowing rose from $113 to $290 million, or by $177 million. We see that mostly in the higher cash balance and the movement of borrowing from short term to long term.

Equity has fallen $205 million from $1.49 to $1.29 billion.

Net cash used for operating activities was $24.3 million in the first two quarters of last year. This year, it was $20.8 million. “The year-over-year change in cash flow associated with operating activities was primarily the result of a change in accounts payable and accrued expenses in connection with the Company’s extension of vendor payment terms, partially offset by an increase in net loss, adjusted for non-cash items.”

Generally, when I see a company with declining sales increase accounts payable and accrued expenses, that tells me they are paying vendors more slowly to conserve cash. That’s supposed to improve operating cash flow. I guess, though, that the quote above doesn’t say it didn’t- just that it was one of the factors in the net result. You know, I’m pretty good at this, and often in various filings for many companies I have a hard time figuring out what’s going on.

Okay, here endeth the financial analysis part of this.

In the 10Q they state:

“Our ongoing efforts to turnaround the business will be focused on:”

“• putting the customer at the center of everything we do;

• defining a clear position for our brands;
• delivering a compelling and differentiated assortment;
• optimizing our brand reach domestically and internationally and optimizing our performance in each channel;
• continuing to improve our efficiency and reduce expense; and,
• ensuring we are organized to succeed. “

Long time readers won’t be surprised when I say, “Well, that’ all good stuff, but how is it different from what everybody else is trying to do? How does it generate any competitive advantage?” The answer is it doesn’t unless you believe they can do these things they admittedly need to do better than their competitors. This is indicative of just how tough the retail market is right now.

How they are doing in these areas is a lot of what the discussion in the conference call revolves around. I want to scurry down to my local mall and see if that Hollister store is one that’s been remodeled. I kind of liked the feel of the old stores. Maybe that’s why they needed to do it differently.

I’m not going to spend much time on the conference call. Most of it is discussion about how they are or are not performing against the six items I highlighted above from their 10Q. Either they will be better at doing this stuff than their competitors or they will not. We’ll find that out as the quarterly numbers come out. There is no magic here.

But I will highlight a few comments they made I think are interesting.

First they note that mobile is generating over 50% of their online traffic. “Across brand, the direct-to-consumer and omnichannel business grew to approximately 21% of total sales versus approximately 19% last year, with growth in both our U.S. and international businesses,” we are told by CFO Joanne C. Crevoiserat. That should not be a surprise to anybody following retail’s evolution.

Hollister Brand President Fran Horowitz-Bonoadies tells us that the improvement in comp store results (remember it’s in constant currency) occurred, “…while continuing to reduce our reliance on promotions across all channels.” I don’t know the extent, but that’s generally a good thing. She also talks, in the U.S., about simplifying “…our promotional pricing to improve clarity and quality and value.” I would imagine their ability to accomplish that also has to do with getting inventory under control. They suggest there’s some more opportunity there.

One analyst made the comment, “…it seems like you’re trying to age up the customer when we come into the stores and see the marketing.” A&F Brand President Christos Angelides responded, “Actually, that’s not a deliberate plan of ours to age up the customer. We’re actually thinking less about age and more about style and attitude. So, any changes you may see in store are really the result of the way that customers are taking us to that direction. So, just to emphasize, we’re not deliberately trying to age the customer; that may be a function of those that shop with us.”

I find that encouraging and correct, but also dangerous for all retailers. Wherever you go, there you’ll be, and if your adventure in customer following takes you too far afield, you may find risk losing control of your brand and its positioning.

As you may also recall, the A&F brand had some troubles with acceptance of its logoed product. They indicate that the changes they’ve made are allowing them to move past that, but I can’t think of a bigger red flag for your brand than the customer not liking the logo. Chief Operating Officer Jonathan E. Ramsden, not necessarily referring to the logo issue, says, “There is probably some additional baggage that A&F carries related to the historical issues.” He isn’t specific, but if you go read the article I provided a link to early in this article, you’ll see what he’s referring to.

Finally, I’d note that the company is giving its sales associates and store managers some more autonomous and compensating them for results. I don’t know the details, but it feels like the right way to go assuming, of course, that they have the right sales associates.

So we wait. In an over retailed environment, A&F is betting it can do what its competitors are doing better than they can do it.