By and  on December 28, 2004

NEW YORK — Disappointing holiday sales don’t tell the whole story.

While retailers spent Monday crunching the numbers from the Christmas season, the subtexts of 2004 are the continuing boom of gift cards and growing Internet sales, an extended shopping season (well into January) and a reengineering of the financial dynamics propelling stores through the fourth quarter.

And all of those add up to what are expected to be strong fourth-quarter profits for stores even as they report less-than-stellar holiday sales.

Stores often receive low marks for merchandising creativity, growing the top line, capturing new customers and for service, which hardly exists.

But when it comes to what counts the most — the bottom line — retailers are expected to come out fine. That’s due to nimble inventory management, cost and employment controls, not pushing the panic button on markdowns during this challenging holiday season, and a post-Christmas week that’s taking off.

“Retailers have done a good job of financial engineering,” noted Carl Steidtmann, chief economist with Deloitte Research. “I don’t think we’re seeing nearly the same level of promotional activity as a year ago. Retailers are very disciplined. They are maintaining inventories very tightly and they have kept their employment pretty tight.”

What does inventory control entail? It’s all about “having the right inventory, being able to recognize good sellers early, stocking up on those and cutting losses quickly, maintaining close relationships with suppliers to respond quickly to changes with consumer demands,” Steidtmann said. Some retailers have also employed markdown management software to control promotions, and therefore, profits. The results are measurable.

Steidtmann predicted operating profit gains for the fourth quarter, on average, will be in the low double digits, and the year’s profits “will be along those lines as well, if not a little better,” he said, considering the current quarter is up against a strong comparison to a year ago and spring ’04 was so buoyant.

The fourth quarter for apparel retailers accounts for about 40 percent of annual sales and roughly 50 percent of annual profits, Steidtmann said. Jewelry retailers would score more of their sales and profits in the fourth quarter, and food retailers would score less, he noted.Financial and retail sources said January represents roughly 15 percent of the fourth quarter’s volume, while December accounts for about half, and November is in the 35 percent range. The National Retail Federation has predicted that the holiday season would yield 4 to 4.5 percent total sales gains for retailers, while Steidtmann more optimistically forecasted they would be 5.5 to 6 percent ahead.

Adding to the confidence are reports that Christmas Eve and the day after Christmas were big traffic days at the malls and downtown stores, making up for some of the sluggishness through most of December. Apparently, shoppers are eager to redeem gift cards (this Christmas season’s number-one holiday item), exchange gifts and take advantage of clearances that continue into February and enable stores to display fresh spring merchandise. Based on the past couple of selling days, the post-Christmas week is expected to be a big volume period. It’s been growing in significance for the last several years.

“We saw a lot of people coming out [to shop] at the last minute, the day before and the day after Christmas,” said Louis Fortunoff, executive vice president of Fortunoff’s. As far as the overall holiday season, “It just seems the period is compressed to the week before and the week after Christmas. It wasn’t an easy season. It was tough.”

Said a Bloomingdale’s spokesman: “We were very excited about the day before [Christmas] and day afterward. It was as incredible as a year ago with electronic gift cards, fine jewelry, luxury and better merchandise selling.”

However, while the last week of December is big, the rush doesn’t spill too deep into January, which is not considered a major volume month. Instead, it’s a period of taking inventory, settling up with vendors on markdown money and making a lot of adjustments for shrinkages and taxes. In addition, gift cards from a couple of years ago, if not redeemed, can be put on the books to bolster the quarter’s results.

“The January performance in profits is not a true number because of all the year-end adjustments, and from a volume point of view, January is really meaningless,” said a former retail chief executive officer. “January is a period of reconciling. If you didn’t have a good December, January is not going to save you.”Weather factors add to the uncertainty of January, though volume starts to pick up again in February as Valentine’s Day and Presidents’ Day approach. Still, spring 2005 will be tough since retailers are up against a robust spring 2004. “If December was disappointing, why would spring be that good when you are up against very good numbers from last year?” said the former retail ceo.

This year, said retailers, the pattern of business has been up and down, but mostly up. Business started off gangbusters in the spring, then hit a wall in September, partly due to the hurricanes and cold weather. October and November were OK, but business levels in December fell short of expectations.

“It’s been a difficult season [sales-wise], but most people like ourselves have a better handle on our inventory and probably have been able to reduce markdowns, which will help profitability a bit,” observed Ken Lakin, chairman and chief executive officer of Boscov’s, the Pennsylvania-based department store chain.

Consumer confidence and spending have been dragged down by macroeconomic forces such as stagnant real wage growth, higher health care costs and higher fuel oil prices, forcing retailers to shift their focus from chasing hefty top-line growth to growing sales incrementally while maximizing profits.

This strategy requires retailers to become better managers of their inventories. As a result, retailers entered the holiday shopping season this year in good fiscal shape. Their inventories were leaner while gross margin rates were significantly higher.

Of the two dozen major, publicly traded retailers tracked by WWD, 19 reported higher year-over-year gross margin rates in the third quarter. And in some cases, the gains were astounding.

For example, American Eagle Outfitters watched its gross margin rate jump over 900 basis points to 47.15 percent in the third quarter from 38.06 in the prior year while J.C. Penney soared over 230 basis points to 40.80 percent from 38.50 percent. Other big gainers include Kmart Holding Corp., Bebe Stores, Saks Inc., Stage Stores and Urban Outfitters.

Robert Drbul, who covers the broadlines and department store sector for Lehman Brothers, said in a research note Monday that while he expects softer sales this holiday, which led to stepped-up markdowns in the department store segment, “we believe margins will hold up in the fourth quarter due to leaner inventory positions going into the holiday season.”Drbul is calling for a 2 to 2.5 percent sales increase of the broadline and department stores retailers on his radar. His top picks include Target, Coach, Costco and Nordstrom.

Like others, he said the week following Christmas has become an increasingly important component of holiday sales, representing 14 percent of them in 2003, up from 10 percent in 2000. “This growth has been largely driven by the emergence of gift cards, which we believe could represent 8 to 10 percent of total holiday sales this year, most of which fall after Christmas.”

In the apparel realm, high-end handbags and jewelry, ponchos, cashmere, boots, denim and items with fur trim, color and embellishments were standouts, though many store executives believed there were not enough hot items to propel them through the season.

Taking share from apparel are the home goods and consumer electronics segments, with plasma and LCD flat-panel televisions as well as digital cameras, iPods and Nintendos selling particularly well. Interestingly, retailers selling electronics dropped prices on flat-panel TVs and digital cameras, but the entry-level iPods sold at $299.99, the same price everywhere, and the same price point it sold at last year. The consumer interest in electronics was evident by the pre- and post-Christmas crowds at stores such as Best Buy and Circuit City. Even smaller consumer electronics retailers enjoyed more robust sales, but at least one felt the pinch of online retailing.

At Electronics Expo, based in Succasunna, N.J., same-store sales were tracking in the high-single digits — just shy of double-digit expectations, said Leon Temiz, president and chief executive officer. “We hit our goal, but did not hit our stretch goal — it was a good Christmas, but wasn’t tremendous.”

Temiz attributed the slight shortfall to a shift in shopping toward online channels for items such as digital cameras and camcorders.

Holiday sales drivers at Electronics Expo included digital cameras, iPods and other MP3 players, satellite radio, DVD camcorders, larger-size plasma televisions (42 inches and above) and LCD televisions, Temiz said.

“The consumer went into the holiday in pretty good shape,” Steidtmann said, citing good employment growth, continued refinancings and tax reductions having positive effects, though rising fuel costs were a negative.— With contributions from Michael Rudnick

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