Abercrombie & Fitch Quarter: Trends Impacting Us All

Consistent with other retailers, A&F’s numbers for their August 3 quarter were not so good. Let’s look at those numbers and then talk about the general trends I think are impacting most retailers in our space.

The Numbers
 
Net sales fell about 1% from $951 to $946 million. U.S. sales were down 8% compared to last year’s quarter, while international rose 15%. The impact of foreign currency rates benefited this quarter’s sales by about $3.4 million.
 
Direct from the 10Q, here’s how the sales number break down:
 
 
You might take a look at sales by brand in dollars and then at the comparable store sales change below that. You’ll note that overall comparable store sales fell 10% even though total sales were down just 1%. Including direct to consumer, they were down 11% in the U.S. and 7% internationally. Hollister comparable store sales fell 13%.
 
The comparable store sales decline was “…partially off-set by new international stores and the impact of the calendar shift, that resulted from the 53-week fiscal year in Fiscal 2012.”
 
Let’s talk about this calendar shift stuff. The retail calendar is divided into 52 weeks of seven days each. Simple enough. But that’s only 364 days and leaves an extra day each year to be accounted for. So every five to six years a week is added to the fiscal calendar.
 
In the words of VP of Finance Brian Logan, “…due to the calendar shift from the 53rd week in fiscal 2012, the prior year comparable 13-week period ended August 4, 2012, had approximately $44 million of additional sales versus the reported 13-week period ended July 28, 2012, which provided a benefit to second quarter year-over-year sales and earnings.” The point is that this quarter looks, comparatively speaking, better than it would have if the extra week hadn’t dragged sales from one quarter to another last year.
 
As you may have noticed, all the retailers are talking about it this year. Thank god we won’t have to deal with it again for another six years now.
 
Okay, still on sales, let’s look at how A&F did by region. Here’s another chart from the 10Q.
 
 
You can see the U.S. took a big hit. I’ve included the 26 week results as well just so you can see  the 5% sales decline over that period.
 
Saving their bacon for the quarter was an increase in gross margin from 62.3% to 63.9%. They tell us the improvement was “…primarily driven by lower product costs.” What they don’t tell us is whether the lower product was the result of epic, creative, insightful management efforts or pure dumb luck. If they’d done some good management things to make that happen, you’d expect they’d tell us. On the other hand, they are in the middle of a profit improvement plan that’s supposed to generate in excess of $100 million annually. But much of that isn’t supposed to be realized until 2014. Okay, let’s say it’s the profit improvement plan. May well be.
 
Store and distribution expense rose from $592 to $604 million. As percentage of sales, it increased from 48.1% to 49.9% quarter over quarter. We aren’t really told why. Marketing, general and administrative expenses rose from $458 to $471 million and from 11.7% of sales to 12.4%. The increase was “…primarily driven by increases in consulting and other services.” It includes “…$2.6 million related to the implementation of the ongoing profit improvement initiative.”
 
During the quarter, and reflective of some of this expense, A&F opened four international Hollister chain stores and two A&F outlet stores- one in the U.S. and one in the U.K. So far this fiscal year, they’ve closed seven stores in the U.S. and one in Canada. They expect that by the end of the year they will have closed a total of 40 to 50 U.S. stores. The remainder of the closures will all happen at the end of the year as leases expire.
 
Net income for the quarter was $11.4 million, down from $17.1 million in last year’s quarter. For the fiscal year to date, they’ve got a profit of $4.2 million compared to a loss of $4.3 million in last year’s first half.
 
Net cash used for operating activities for the year to date is $209 million, compared to $24.3 million in the prior year. About $98 million of that increase is for shares repurchased. Inventory was down by 9% compared to last year’s quarter. They’d expected it to be down by more.
 
Trends and Strategies
 
A&F didn’t give any guidance as to future results beyond the current quarter “Due to the lack of visibility given the recent traffic trends…” CEO Mike Jeffries talked about the market this way:
 
“The reasons for the weak traffic we’ve seen in the U.S. are not entirely clear. Our best theory is that while consumers in general are feeling better about the overall economic environment, it is less the case for the young consumer. In addition, we believe youth spending has likely diverted to other categories. We assume that these effects will abate at some point, but until we have seen clear evidence of that, we are planning sales, inventory and expense levels on a conservative basis.”
 
He goes on to discuss their profit improvement plan (mentioned above) and ongoing long term strategic review. He notes, “…the plan emerging from this review will map out clear strategies covering our assortment, our real estate plans, direct-to-consumer, omni channel, technology, marketing and CRM and sourcing. We are confident that these plans will give us a clear roadmap for sustainable growth in sales, profitability and return on invested capital.”
 
To me, the most amazing part of his presentation is where he says, “We assume these effects will abate at some point” to which I respond, “Why?” If he really believed that- if he didn’t think things were changing dramatically- why is the long term strategic review necessary?
 
At one point an analyst asks, “I’m just wondering if you could maybe comment on the potential for maybe non-traditional competition within the teen space potentially driving some of the weakness that you’re seeing across the entire industry from you and some of your competitors. Is there perhaps a structural change that’s occurred? And is that what we’re seeing within the teen category?”
 
Mr. Jeffries answer is, “…I think you’re right on in terms of the potential for non-traditional competition. It’s happening and we’re — we want to be in the forefront of that. I think what we own is very powerful brands. And owning those brands, we think we’re going to be able to be in the forefront of the non-traditional brick-and-mortar part of the business.”
 
CFO Jonathan Ramsden, responding to a question about what won’t change in the business model, says “…the core aesthetic and what the brands stand for.”
 
There’s an understandable limit as to what I expect management to disclose in a conference call. And it’s certainly not a problem that’s unique to A&F. But assuming things will go back to the way they were when “…youth spending has likely diverted to other categories” and stating that the ”core aesthetics and what the brands stand for” won’t change seem like they could be incompatible statements.
 
In his excellent book The Black Swan, Nassim Taleb talks about the life cycle of the turkey. From the day it’s born, everybody takes really good care of him. They feed him, give him medicine, keep him warm and don’t ask him to do anything. If you asked the turkey what tomorrow is going to be like he’ll say, “Why just as good as today.” The turkey doesn’t know tomorrow is Thanksgiving.
 
We’re in a market where where you need to be particularly careful in examining your assumptions.