Stumbling Blocks at ANN

Last week, ANN (NYSE: ANN) updated its quarterly outlook, and things aren't looking great. Comparable sales are forecast to be down, gross margin compressed, and expenses up. The company owns both the Ann Taylor and Loft brands, with Ann Taylor focusing on higher-end consumers and Loft aiming at a younger, price-conscious crowd.

Both brands also have an outlet channel, but sales at those outlets are looking even grimmer. With everything turning against the retailer, is there anything left for investors to be excited about?

Retail vs. outlet
Looking at ANN's newest release, you'll quickly see the distinction between the company's two main channels. Ann Taylor outlets are forecast to have a 5.8% decrease in comparable sales, and Loft outlets are expecting a 7.9% drop. Conversely, the retail channels of Ann Taylor and Loft are expecting a 6.2% increase and a 0.9% decrease, respectively.

The drag in sales at the outlets has resulted from ANN focusing on profitability in that channel. On the company's last earnings call, it highlighted that focus, saying that it had "managed the LOFT Outlet business for profitability this quarter."

That worked out in the fourth quarter, and the company was able to sell more consistently at a higher price point. The trade-off for that profitability was in volume, and gross margin increased over the quarter. The balance for investors is going to be finding a happy medium between sales and profitability. So far, ANN has been unable to strike that balance.

The missing pieces
Right now, it seems like ANN is having trouble walking a thin line. The company could learn a lot from Coach (COH 1.89%), which has found a more subtle way to make its factory outlet locations work. Recently, the company has moved away from broad discounting, which erodes margins, to focused discounting on specific products. Management has claimed that the approach has "had an incredible impact on mix and ticket within the factory channel."

ANN has the potential to refine its own approach. The rise in comparable sales at Ann Taylor retail stores is a result of the company being able to produce products that customers want and that fit the current seasonal trends. In other words, ANN has figured out the basics of successful apparel sales at Ann Taylor.

The gap between that success and the shortfall in the outlet stores can be overcome if ANN can entice customers without relying on promotional systems. The Coach approach of targeted sales could make a big difference for ANN, but it's not yet clear to me that management can handle all the moving pieces. For now, the fact that ANN is struggling with three of its four brands puts me off the company, but there is distinct turnaround potential here, and more adventurous investors could strike gold.