MARKET WATCH: Should You Be Thrilled, or Worried About Hollister’s Performance?

Jeff Harbaugh

• December 12 2008
• 725 views
• 4 comments

Abercrombie and Fitch’s quarter ended November 1st was soft. Net sales for the quarter were down 8% to $896 million. Gross profit percentage fell just slightly from 66.2 to 66%. Stores and distribution expense rose 8.65% to $386.5 million. Other expenses were more or less constant. The result was that operating income fell from $186.6 to $100.1 million, or 46.4%. Diluted net income per share fell from $1.29 to $0.72 a share. Here’s the link to the filing.

Most people don’t want to spend a lot of time on this stuff (hence you read what I write), but I really recommend you take the time to look at the Financial Summary on page 21. It’s a great breakdown on their sales and results by kind of store. I wish more companies gave us data presented this well.

It shows their comparable store sales were down 14% for the quarter. Hollister sales were down 18%. It also gives easy to read data on stuff like net retail sales per average store, average retail transaction value, net sales by brand, and a bunch of others all broken down by type of store. It’s one page and I really urge you to take a look at it.

At November 1st, the company had 1,106 stores. The largest number, 499, were Hollister. 357 were Abercrombie & Fitch, and 210 Abercrombie.

I know there has been a lot of dislike/concern about Hollister, but I’m wondering if we should feel happiness at its sales decline. Hollister gets castigated for being a “fake” surf store and I suppose that’s true as the industry means it. But somehow, they’ve been selling a lot of stuff to people interested in what they perceive to be the surf lifestyle. At the end of the day, the more the surf industry grows, the more it has to sell to exactly this group. Unless you think the customer who’s walking out of Hollister is walking into your core shop to buy your core brand, I’m not sure this decline is what we want to see.

By the usual measures, the balance sheet has stayed about the same year since a year. The one difference I want to point out is the marketable securities under current assets went from $277 million to zero. This has to do with the credit crunch and problems with the liquidity of these auction rate securities. Because the market for that kind of security has kind of seized up, Abercrombie chose to reclassify $261.8 million of these investments from current to non-current assets.

An asset is classified as current if it is expected to be and can be liquidated within a year. Basically, Abercrombie (and everybody else with this problem as I’ve written before) doesn’t know when they will be able to sell these securities. They aren’t writing them down- they are just reclassifying them. They expect that in the course of time, the markets will recover and they will have access to their funds.

They say that they don’t expect this to have a material impact on the company’s overall liquidity because they expect that, “…substantially all future operations, including projected growth, seasonal requirements and capital expenditures will be funded with cash from operations.”

Well, good for them if they can get along without $261 million. The thing that makes me nervous (and not just for Abercrombie) is that they classify the whole amount as what’s known as Level 3 in accounting standards. That is, “inputs to the valuation methodology are unobservable.”
Here’s what they say about how they valued those securities:

“The level 3 assets are investments in insured student loan backed securities and insured municipal authority bonds ARS and were transferred from Level 2 in the first quarter of Fiscal 2008 as a result of a change in market conditions. As a result of the market failure and lack of liquidity in the current ARS market, ARS were valued using a discounted cash flow model to determine the estimated fair value of these securities as of November 1, 2008. Certain significant inputs into the model are unobservable in the market including the periodic coupon rate, market required rate of return and expected term. The coupon rate is estimated using the results of a regression analysis factoring in historical data on the par swap rate and the maximum coupon rate paid in the event of failure.”

It goes on, but I figured that was all I could get anybody to read. It would have been a lot more readable if they’d just said, “We don’t know what these damned things are worth!” But I guess that wouldn’t be complicated enough for an SEC filing.

In talking about the Current Trends and Outlook, Abercrombie acknowledges that the selling environment is difficult. Then they describe how they are managing their business:

“…the Company managed its business in the third quarter with a long-term and disciplined approach. The Company moderated expense, but did so without compromising the aspirational shopping experience. It maintained its full price strategy that is based on product quality, not promotion, only using markdowns to clear through seasonal merchandise in a brand positive way. The Company views promotions as short-term relief that is more than offset by the damage inflicted on the brand for the long-term.”

That’s very similar to what Billabong said when they revised their guidance. Though I support the strategy conceptually, I wonder if there isn’t a more fundamental issue, given the size of the quarterly decline in sales, that will make them reconsider it

Jeff Harbaugh is a consultant for the action sports industry and works with companies to identify and focus on critical business issues and opportunities fundamental to the bottom line. For more information, visit www.jeffharbaugh.com.

(Photo: Kanaka’s Paradise Life, Creative Commons)