LNT profits sink over change

CLIFTON, N.J. — Hit by a change in the way it accounts for vendor allowances, and then by a downturn in business that took a bite out of sales, second-quarter profits at Linens 'n Things slumped 84.6 percent, to $879,000 from $5.7 million.

The big dive at the bottom line was triggered almost entirely by a non-cash item — a change in accounting that requires the home furnishings retailer to pull out of this year's results, at least on paper, the cash it takes in from suppliers in the form of chargebacks, slotting fees, markdown money and allowances.

Put the vendor allowances back into this year's numbers to create an apples-to-apples comparison, and earnings declined at a more moderate pace of 13.8 percent, stung by a slowdown in traffic and sales.

Underlining the crucial importance of chargebacks and allowances to a retailer's bottom line — as they become a profit center in themselves — Linens 'n Things took in $4.1 million in the form of vendor allowances during the quarter, but made only $879,000 from the act of selling merchandise. Putting it another way — more than 82 percent of the retailer's real second quarter profit came from the substantial sums of cash it siphons out of its suppliers.

It's important to note that the accounting change involved is a non-cash item that has no affect on the company's cash flow or its hard-cash earnings, just the way it accounts for them on paper.

Sales at the big-box specialty retailer increased 10.5 percent, to $578.7 million from $523.7 million last year. Same-store sales were virtually flat, edging up just 0.2 percent, hit by "a slowdown in guest traffic during the quarter," said CEO Norman Axelrod.

While the change in accounting highlights the critical contribution of vendor allowances, by pulling them out of the equation this year it also tends to obscure the company's overall performance. This is evident as virtually every line in the retailer's income statement has been skewed by the change.

For example, the retailer's reported operating profit was $1.6 million, down 83.1 percent. But excluding the impact of the non-cash accounting change, operating profits were down at a sharply slower pace of 13.8 percent.

As reported, average gross margin declined from a year ago, to 40.2 percent from 40.8 percent. But excluding the non-cash accounting charge, margins were stable and unchanged.

Operating costs, as reported, climbed to 39.9 percent of sales from 39 percent a year ago. Absent the accounting change, costs rose at a far slower pace, to 39.3 percent.

On an unambiguous and upbeat note, the retailer reduced its interest expense by more than a third, to $188,000 from $288,000 last year, generating a cash savings of $100,000.

In a further cash savings, inventories were kept lean, rising well beneath the rate of sales growth. Inventories rose 7 percent, to $765.7 million from $715.6 million, moving up at a slower pace than the 10.5 percent increase in sales.