Turnaround for Queen Spades
Board: Value Hounds
Fifth & Pacific (FNP) now Kate Spade (KATE) is a company undergoing massive transformations. That probably leaves investors confused—who are they? It’s a long and tortuous story so here is the short version—shortish anyway.
FNP was Liz Claiborne founded by Liz Claiborne in 1976 along with her husband and a couple of others. Liz was CEO and chairman and took the company from nothing to $2.2 billion in sales by the early 1990’s. Liz C. began an acquisition binge starting in the late 1990’s through 2006 and one of their luckiest acquisitions was Kate Spade for $124 million. The rest have been mediocre to disastrous.
Liz’s inexplicable decision in 2006 giving exclusive lines to J.C. Penney instead of longtime business partner Macy’s came back to bite them in 2007. Macy’s slashed orders in Q1 2007 cutting Liz’s earnings by 65% and the stock crashed. Claiborne dies in June 2007 and her company went to hell in a hand basket from there. Liz C. tried and failed over and over to find a fashion face to lead the company and all of them went down in flames. Meanwhile Penney was dying its own quiet death and fading into senescence along with Liz’s once cutting edge name brand. Designers at Liz Claiborne continued to miss the trends and the stock lost 90% of its value and money. By 2010 all Liz stores were shut and bankruptcy rumors ran wild. Brands were sold off –some at big losses. The Liz Claiborne brand itself was sold to J.C. Penney for $228 million. In 2011, in spite of the segment sales and streamlining, the company lost more money.
In 2012 Liz Claiborne was rebranded as Fifth & Pacific (FNP) and segments were cut to four brands including Kate Spade. Wall Street expected this shadow of its former self to be taken private by KKR but that hasn’t materialized yet. Against all odds, FNP now has a winning concept and will be rebranded again taking the Kate Spade name the only name worth saving. Additionally, chairman and CEO William L. McComb is leaving the company after seven years, to be replaced by Kate Spade CEO Craig Leavitt. FNP aka Kate Spade has done extraordinarily well under Leavitt over the years and his move to CEO of the company should be successful.
Kate Spade is actually Kate Spadeless and Kate hasn’t been there since she and her husband sold out in 2007. The recent fashion hits and beautiful business were done under the guidance of Leavitt with designers Deborah Lloyd and Brad Goreski. Craig Leavitt was brought in around the same time as Deborah Lloyd in 2008, following the departures of Kate and Jack Spade, and he is credited with revitalizing the brand and overseeing its domestic an international expansion.
This past October, Fifth and Pacific sold the dying Juicy Couture brand to Authentic Brands for $195 million—they were lucky to get it off the their hands. On December 10th, they sold the somewhat better performer Lucky Brand to private equity firm Leonard Green for $225 million. That leaves the Kate Spade brand as their “face” and so far Kate Spade has been stellar.
Twenty years ago, Kate Spade launched her company, Kate Spade New York, with a collection of nylon bags. The design was a boxy nylon handbag that defined the look. The Spades sold the brand to Neiman Marcus in 1999 and in 2006 Spade went to Liz Claiborne. Sales growth for KS went from $91 million to $743 million in 2013. Plans are for Kate Spade New York to reach 475-550 company-owned and partnered owned stores worldwide with 250-300 in North America. Kate Spade New York has 149 retail and outlet stores, nine Kate Spade Saturday stores and 12 Jack Spade stores. The concepts biggest growth appears to be ahead of it if the brand stays hot with high store counts and high comps.
•?Sold 100.0% of the capital stock of Lucky Brand Dungarees for $225.0 million
•?Reacquired the existing KATE SPADE businesses in Southeast Asia from Globalluxe for $32.0 million
•?Sold Juicy Couture to ABG for $195.0 million
•Has an agreement to terminate the Juicy Couture flagship store on Fifth Avenue in New York in exchange for $51.0 million in cash
•Sold the West Chester, Ohio distribution center for $20.3 million and is doing a sale-leaseback
•?Sold the North Bergen, NJ office for $8.7 million and are doing a sale-leaseback
•?Launched the Kate Spade Saturday brand
KATE has a desperate need for cash and anything they can do to raise some including sale-leaseback will help. Debt levels are high and interest expense is crushing them. They have been aggressively downsizing to get to a monobrand that has substance and a star-power brand name. Kate Spade will be the only retail brand standing at the end with Adelington as a minor licensing business.
As FNP the company struggled for years under the black cloud of has-beens and irrelevant poorly performing trade names like Liz Claiborne, Lucky, MEXX, DKNY and Juicy Couture. Revenue and earnings growth have been a faint sweet memory from the last century—about when the Liz Claiborne style hopelessly jumped the shark. Kate Spade has been their one and only star and the company is astute enough to realize it’s the only brand they want associated with their business.
Details of the Juicy Couture (JC) wind-down
The company will pay guaranteed minimum royalties to ABG of $10.0 million during the term of the wind-down license. Around 30 of the JC stores will be converted to Kate Spade. There could be significant restructuring charges associated with the JC divestiture estimated around $40-$50 million and that could impact 2014 results. That could be offset by $51 million from the lease termination making the losses negligible.
Juicy Couture results are still on the financial statements and Lucky isn’t and is accounted for as a discontinued operation making year-over-year evaluations of the business difficult. For 2013 the $1264 in revenue doesn’t include over $400 million from Lucky that is discontinued.
Expansion into Asia
The company is busy opening stores in China and Japan. In 2013 stores in Japan (wholly-owned following the buyout of their joint venture partner in Q4 2012) had revenue growth of 36% with comps at 19%. In Q4, Kate Spade posted organic comps of 26%.
They reacquired the existing Kate Spade businesses in Southeast Asia from Globalluxe Kate Spade for $32.0 million. That brought in a total of 14 stores across Singapore, Macau, Taiwan, Hong Kong and Malaysia that generated approximately $44 million in retail equivalent sales. They intend for international sales to be 66% of revenue and as we have seen with Coach and KORs, Asia and specifically China are the hotspots.
Kate Spade Saturday
Kate Spade Saturday was launched in the US during the first quarter of 2013. Prices are lower and the target demographic is younger with less money to spend. Kate Spade Saturday will use simple straightforward shapes, and go-anywhere silhouettes featuring bold colors, strong prints, and honest materials like crisp cotton, canvas, and natural vachetta. Kate Spade Saturday is creating product that is versatile and multi-functional.
The new multi-category brand will offer apparel (including dresses, jackets, denim, t-shirts, sweaters, and swimwear) and accessories (including handbags, small leather goods, jewelry, watches, footwear, eyewear, and tech accessories), as well as beauty, tabletop, and home decor items. The approximate average retail pricing for all categories are expected to be as follows: apparel ($90), eyewear ($55), fashion accessories ($40), handbags ($130), home ($25), jewelry ($30), shoes ($85), small goods ($45), swim ($50), tech ($30), and watches ($50).
Results for 2013
Revenue for 2013 was $1.265 billion, an increase of $221.5 million or 21.2%, compared to 2012 revenue of $1.043 billion (Lucky not included--$1505 million with Lucky in 2012). Increases were mainly from Kate Spade and those gains were offset by declines in the Juicy Couture and Adelington Design Group segments.
KSJ added $79.3 million increase in net sales in 2013 compared to 2012.
Sales results by segment 2013
•Kate Spade sales were $743.2 million, a 60.9% increase compared to 2012, with increases across all operations in the segment. The acquisition of KSJ contributed $79.3 million. Without the KSJ acquisition, growth was 44%--respectable and in fact impressive.
•Spade ended 2013 with 118 specialty retail stores, 51 outlet stores and 43 concessions-- net additions of 37 specialty retail stores, 11 outlet stores and 11 concessions. Concessions are small areas of selling space in other retail stores.
•Average retail square footage in 2013 was approximately 263,000 SF -- a 54.6% increase.
•Sales were $1,212 per square foot compared to $1,016/SF in 2012 (365 days).
Comps including e-commerce, increased 28.2% and excluding e-commerce comps were up 16.3%. e-commerce is a key part of the Spade business. The e-commerce business experienced a significant increase in traffic, and they found that the shoulder-pricing approach continues to work. During Q4, FNP found consumers were looking for promotional pricing and entry points to the brand, but also were willing to buy aspirational products with prices ranging from $498 all the way to $1,998. Among the highest sell-throughs were the Swarovski statement necklace at $698 and the best-selling Emma dress at $798 with 100% sell-through.
•Adelington net sales were $60.2 million decreasing by $22.6 million, or 27.3%,
•Kate spade Q4 results were due to a 30% increase in comps in Q4 2013 and sales/SF up 14% to $1,265, up 14%
•EBITDA margins contracted 3% to 17.56% from promotional pricing and forex adjustments from the acquisition of Kate Spade Japan. Store opening costs rose as KATE added 40 stores in North America, 7 in China, 2 in Brazil and 6 in Japan.
Less impressive results from the other brands
•Decline of $12.5 million from Liz Claiborne brands
•Lost revenue of $6.6 million from the sale of DKNY and other exited licenses
•Juicy Couture sales were only $461.6 million -- a 7.4% decrease
•Juicy Couture ended the year with 74 specialty retail stores and 53 outlet stores, and a net closure of 4 specialty retail stores, 2 concessions and 1 outlet store.
•Average retail square was approximately 415,000,SF and with the net closures decreased 2.9% compared to 2012.
•Sales were $644 per SF compared to $685 in 2012(365 days)
•?Comps including e-commerce, decreased by 0.6% in 2013 and excluding e-commerce comps were down 4.1%. ??? JC has been anything but Juicy in 2013 with quarter after quarter of declining comps and only ecommerce keeping them from mid-single digit declines.
[See Post for Tables]
Kate Spade Q4 comps were 30%.
Comps for Juicy Couture declined every quarter ending the year at (4.1)%. Sales/SF actually increased but lag Kate Spade by miles. Lucky Brand isn’t as hopeless as JC but it’s not exactly setting retail on fire and is best seen in the rearview mirror.
Kate Spade is the only segment worth holding on to and FNP has made the hard but excellent decision to slash their business to the one retail brand (Adelington is only for licenses and manufacturing to supply specific channels including QVC and JCP)
The Kate Spade stores have higher comps and better business per SF by a huge margin over the other segments with consistently higher same store sales and higher sales per SF every quarter. New stores typically generate sales per square foot in the $700 range after 1 full year and ramp up from there, with a target comp productivity of over $1,200/SF. FNP does see some moderation of productivity growth as the store base matures and expands.
At year-end 2013, there were approximately 135 stores on the comp base including e-com. By year-end 2015, this will grow by approximately 100 stores based on store openings during the last 2 years and planned 2014 store openings, with the largest tranches being added to the comp base in late 2014, early 2015 and then again in the back end of 2015. That’s a 74% increase in stores that are moving into the peak sales per SF territory if history is a guide ie revenue growth and comp growth should remain high.
KATE has a small store base relatively speaking at present and has a long way to run should the brand warrant continued investment in expansion.
Results for 2012
Net sales for 2012 were $1.043 billion, a decrease of $57.1 million or 5.2%. Excluding the impact of a $175.2 million decline in net sales related to sold and exited brands net sales increased $118.1 million -- 10.7%.
The brands that were axed in 2011/2012 include:
•Wholesale sales for the former licensed DKNY® Jeans
•AXCESS wholesale sales
•Licensing revenues related to the LIZ CLAIBORNE family of brands and the Dana Buchman brand due to the sales of the trademark rights
Net sales results for segments:
•?Kate Spade revenue was $461.9 million, a 47.6% increase compared to 2011 including organic growth and $16.0 million in KSJ sales
•Spade had 81 specialty retail stores, 40 outlet stores and 32 concessions
•?Average retail square footage in 2012 was approximately 170 thousand square feet-- a 15.2% increase compared to 2011
•Sales were $1,016 per square foot compared to $934 in 2011
•Comps including e-commerce increased by 29.5% in 2012 and excluding e-commerce increased 21.5%.
Comps in the 20% range are almost the equal of the newly slowing Kors???. While retail square feet increased 15% and comps were up 29.5%, revenue increased 47.6%. Comps plus store growth (proxy SF increase) was 44.5% and I take it as a positive when revenue actually outstrips SF (store growth) plus comps. It indicates that new stores are doing well and growth by increasing square feet is paying its way.
The new transformed business
KATE will be cutting loose nearly $1 billion in revenue by the end of 2014 (Lucky and JC) after all the divestitures are completed. The company is a turnaround story as it remakes its structure and its image. They will lose revenue and earnings in the near-term, but if Kate can hold onto its fashion sense, they will become a clean lean brand capable of taking on the big boys like Coach and Kors.
In 2012, the Lucky and Juicy brands combined to make up 60% of the business and that’s what FNP has cut loose in its big bet on Kate alone. It’s clear cutting out Lucky and Juicy segments was a savvy business strategy jettisoning the slow growing, low margin under performers. With the poorly performing acquisitions the old Fifth & Pacific was a mediocre to ugly business. Making these deep cuts will create a more focused profitable company.
Kate Spade has been gaining momentum over three years and through continuously accelerating growth managed to come from only 11% of revenue four years ago to 31%. Margins for Kate improved every year from 14% to 21% while Juicy went from 19% to 5%.Kate Spade revenue increased 1.5-fold and Juicy dropped 12% over three years.
Not fast retail but not Coach either
Kate Spade as an aspirational brand needs to be flexible and fast responding to changing trends The failure of their product to stay hot is one of the biggest risks to investment. They operate under substantial time constraints producing collections and in order to deliver timely merchandise still relevant to consumers, they schedule a large portion of materials and manufacturing commitments late in the production cycle. The advance commitments create lead times around five months, but considering it took Coach a year to bring one handbag style to market last quarter, this is positively speedy. Cheaper fast fashion can retool styles in just a few weeks, but don't compete in the aspirational luxury space. There is some risk that five-month-old fashions may miss the mark but so far KATE has been more right than wrong.
Debt is high
Debt is a negative for investment in KATE. It’s large, at high rates and interest expense cannot be covered by operating income ie there is no positive coverage ratio.
They issued $225 million in 10.5% senior notes to repurchase euro notes in 2011. This left them with high interest but slightly lower debt levels.
Additional notes were issued a year later to purchase more of the euro notes and KSJ creating a senior debt load of $372.0 million at the margin killing rate of 10.5%. An offer to purchase some of the notes with the $75.0 million from the sale of Lucky Brand is currently underway. KATE is also going to refinance and hopes to decrease interest expense substantially.
In 2012, through a combination of privately negotiated transactions and an optional redemption, the Company repurchased the remaining 121.5 million euro aggregate principal amount of the Euro Notes for total consideration of 125.6 million euro, plus accrued interest. The Company recognized a $5.1 million pretax loss on the extinguishment of debt in 2012 related to these redemptions.
The optional redemption was funded by a portion of the net proceeds from the Company's issuance of $152.0 million aggregate principal amount of 10.5% Senior Secured Notes (the "Additional Notes") in June 2012.
KATE ended 2013 with $130.2 million in cash compared to $59.5 million in 2012 There was $394.2 million in debt compared to $406.3 million in 2012. Part of the decrease was made possible by the sale/leaseback and business divestitures. The company has a consuming need for cash and positive earnings were made possible only by the sale of their business segments and licenses in 2011 and 2013. That is set to change but it may be late 2014 before they see positive earnings without the benefit of one-time gains. Lower interest rates will be a big factor in getting earnings in the black.
From the conference call:
Based upon our improved financial profile resulting from the Juicy and Lucky divestitures, coupled with the strength of the capital markets, we see this is as an opportunity to refinance with less expensive, more flexible debt. In fact, we see this as an opportunity to realize annualized interest savings of approximately $20 million.
Many of you have asked if we plan a permanent reduction in our long-term debt. As Bill has said before, it is our ultimate goal to reduce long-term debt to 0. But in the near term, we want to maintain more-than-ample liquidity to support the planned growth of Kate Spade.
As a result, although we expect to secure less expensive debt during 2014, we don't expect to permanently reduce our long-term debt position during 2014. We also plan to resize and extend our ABL during 2014. Beginning in 2015, we expect to begin managing down our long-term debt with our ultimate goal to have a debt-free balance sheet.
For 2014 total adjusted EBITDA will range between $115 million to $125 million net of foreign currency transaction adjustments. The key driver is Kate Spade adjusted EBITDA, forecasted in the range of $165 million to $175 million--$130.5 million in 2013 and an increase of 30% midrange estimate. The adjusted EBITDA margin improvement will be 100 basis points. After winding down Juicy and divesting Lucky, KATE should be able to reverse the spend on restructuring saving nearly $50 million in SG&A. This will most likely put operating income back into positive numbers and increase margins and earnings.
Annualized Kate Spade direct-to-consumer comps will decrease to 10% to 13% as they decrease promotional selling.
Earnings may also be positively impacted by refinancing expensive debt. They expect interest to be approximately $30 million to $45 million for 2014 compared to $47.24 million in 2013. The low end of this range assumes a refinancing. If they managed to save $17 million in interest, that works out to around 14¢ per share pretax and at the low end it’s 2¢. The faster the refinancing is completed, the better EPS KATE will see.
Following the close of the Lucky Brand sale, our NOL position is anticipated at a level in excess of $450 million. This is available to give the company probable tax benefits going forward. It’s likely they will be able to use their NOLS over the next few years as the transition will continue to be expensive and debt levels will continue to remain high. A tax break will help.
KATE is one of the more intriguing turnaround stories and management's single-minded slashing of the dead F&P and molding of the new KATE is already showing financial improvement.