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NEW YORK — Polo Ralph Lauren’s new zero tolerance policy on merchandise returns may pay dividends in the coming years, but it took a big bite out of first-quarter earnings.

This story first appeared in the August 8, 2002 issue of WWD.  Subscribe Today.

The New York-based designer firm on Wednesday posted a 79.2 percent drop in first-quarter earnings due in part to changes in its wholesale sales strategy, but still managed to beat estimates by a penny.

For the three months ended June 29, income was $6.5 million, or 7 cents, compared with $31.1 million, or 32 cents, in the year-ago quarter. On a pro forma basis, adjusting for the company’s European business and excluding foreign currency translations, income was down 36.1 percent to $8.7 million, or 9 cents, versus $13.6 million, or 14 cents. On a pro forma basis, the company beat Wall Street’s consensus estimates by 3 cents.

Total revenue in the quarter was down 10 percent to $467 million from $517.8 million, but dipped only 1.1 percent from $472.2 million on a pro forma basis. Wholesale sales were down 24 percent to $186.7 million from $245.2 million, but just 7.4 percent to $201.8 million on a pro forma basis.

Retail sales were the bright spot, rising 5.2 percent to $227.1 million from $215.9 million, and up 4.3 percent from $217.8 million pro forma. Comparable-store sales in the quarter were up 1.2 percent. Licensing revenue was down 6.3 percent to $53.1 million from $56.8 million, but up 1.2 percent pro forma from $52.5 million.

Roger Farah, president and chief operating officer, said that the no-return decision resulted in lower men’s wholesale shipments throughout the reported quarter, as planned, as retailers took a closer look at up-front buys without the safety net of returns. Women’s wholesale operations were less affected because the business is smaller and, in relative terms, stronger at the moment.

Also contributing to the down quarter was the shifting in delivery of fall merchandise and resortwear closer to their in-selling periods.

The return-policy change not only affected the company’s quarterly results, but also effected a decrease in merchandise available at the company’s outlet stores and at off-price stores. Units available for sale in the secondary market were down about 80 percent from year-ago levels, Farah said. The change in strategy and policy, he noted, will boost profits through increased full-priced sell-throughs and enhance brand positioning of the company’s products via decreased sales at the off-price channel.

If Wall Street had a problem with the strategic adjustment, it wasn’t apparent in trading on Wednesday. Polo closed up $1.16, or 5.8 percent, at $21.06, as the Dow Jones Industrial Average managed a second consecutive day of triple-digit advances. The New York Stock Exchange closed at 8,456.15, up 182.06 or 2.2 percent, while the Nasdaq Composite advanced 1.7 percent to 1,280.92. The Standard & Poor’s Retail Index accelerated less buoyantly, adding 3.71 points, or 1.4 percent, to end the day at 272.37.

Farah told analysts that department stores weren’t getting anything from the company as a trade-off to offset the no-return policy. The company’s willingness to sell less product and at more appropriate levels, he noted, is a win-win strategy for everyone in part because it paves the way for a healthier brand long term.

In addition, the company was hurt by its decision to eliminate its Ralph Lauren Sport business, which created shutdown costs and expenses related to “support” of its department store accounts that migrated from the line.

In its place is the new Blue label women’s line, which will be available only at Polo Ralph Lauren stores. Considered complementary to the men’s Polo line and a notch below the luxury Black label line, Blue targets the tastes of women who want quality, everyday apparel. According to Farah, Blue is planned as the “backbone of our specialty store strategy,” one that will allow the company to become a “more serious vertical retail business” and expand the Polo stores to markets and locations separate from its luxury Ralph Lauren stores.

Prior to the company’s announcement of first-quarter results, analysts had expected that the radical change in wholesale sales strategy would result in a decline in first-quarter profits in the 65 percent range, based on pro forma data, with second-quarter profits possibly falling in the 25 to 40 percent range. At least one analyst, Jeffrey Edelman of UBS Warburg, is expecting an upside in the second half.

The analyst wrote in a research update earlier this week: “Second-half earnings’ contribution should approximate about 65 percent of fiscal year 2003 earnings compared to around 50 percent last year, benefiting from the introduction of the new women’s Polo Blue Label and a higher level of profits from its retail division, whose margins were under heavy pressure last year.”

Farah said: “The early read on Blue label is that we have so far very strong selling in mesh shirts, cargo pants, novelty sweaters and ruffle shirts. We’ve gotten a really good early fall reaction to the line.”

He disclosed that other parts of the business are also doing well based on strong early sales indicators. The women’s collection business is up 19 percent in year-over-year sales so far, with customers reacting positively to the color black. “We’ve also had terrific sell-throughs with our suede jackets,” Farah noted. In the Black label collection, cashmere remains a must-have item for fall, with sales for the luxury product up 40 percent in year-over-year results so far.

At Club Monaco, skirt sales have shot up 33 percent as styles ranging from pleated and paisley to novelty and prints have all performed well. “In many cases, we’ve had several skirt styles selling over 10,000 units each. Woven shirts are particularly strong and are up 100 percent over last year. Both items are really leading the early charge in the Club Monaco business,” Farah said.

During a conference call to Wall Street analysts, the president said: “I’m pleased with our performance for the quarter. We have managed our business well in what continues to be a challenging environment.”

Not mentioned at all during the call, not even during the segment when analysts ask questions about company operations, were the buzz phrases “corporate governance” or “stock options.”

Farah told WWD: “We are a very pristine company in terms of how we do our books and in our accounting. We are very conservative in nature, and have either adopted or explored recommendations concerning changes to our policies or procedures. If and when the President or the Securities and Exchange Commission pushes through a bill requiring stock options be expensed as a line item, then we will do that too.”

The company said it was still comfortable with estimates for the fiscal year of between $1.80 and $1.90 in earnings per share.

“I actually think that by the holiday selling season this year, we may begin to see a more positive mood. Some of these financial scandals making the news may begin to recede. Hopefully, things will become more normalized and that will bode well for the year,” Farah said.

Second-quarter EPS guidance remains unchanged at between 48 cents and 53 cents. The company also provided initial forecasts for third-quarter EPS at between 45 cents and 50 cents and for the fourth quarter at between 75 cents and 80 cents.

Farah disclosed that the company ended the quarter with $371.6 million in cash, and with the improvements in its infrastructure and supply-chain logistics, is in a better position to “assimilate acquisitions.” He indicated that licensed products would be the area where the company would seriously consider acquisitions.