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<DAILY TROUBLE>
Friday, December 4, 1998
Donna Karan International
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Phone: 212-789-1500
Website: http://www.donnakaran.com
Price (12/3/98): $6 13/16
HOW DID IT FIND TROUBLE?
Donna Karan has been seriously out of fashion for a while. The apparel design house went public at $24 in June 1996 and briefly wowed the glitterati with a move to $30 before heading to the discount rack. Turnaround talk earlier this year proved premature as the stock returned to Filene's for further markdowns.
Donna Karan's troubles began with Donna herself. The famous designer proved ill-suited for the CEO job, no matter how nicely layered her attire. Knowing hemlines is great, but DK needed somebody to manage the bottom line. Hello, John Idol.
A former Polo Ralph Lauren <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RL)") else Response.Write("(NYSE: RL)") end if %> executive, Idol took charge in August 1997 and made matinee moves to make Donna Karan less dependent on its core wholesale biz. He's signed a string of licensing deals, including agreements with Liz Claiborne <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LIZ)") else Response.Write("(NYSE: LIZ)") end if %> to market the DKNY Jeans and Active brands lines and with Estee Lauder <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: EL)") else Response.Write("(NYSE: EL)") end if %> to take over DK's beauty products. He's also started opening full-price, freestanding Donna Karan retail stores in an effort to reposition DKNY as a popular lifestyle brand a la Ralph and Tommy Hilfiger <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TOM)") else Response.Write("(NYSE: TOM)") end if %>.
Still, the turnaround keeps turning back. Some observers think Liz is hurting Donna by cannibalizing sales. A larger issue is that the DKNY lines have yet to be fully repositioned, so they still look too expensive relative to sportswear from Ralph, Tommy, and Nautica <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: NAUT)") else Response.Write("(Nasdaq: NAUT)") end if %>.
This mixed bag was reflected in the Q3 results, which came in at $0.35 per share, up from $0.04 last year but a nickel below estimates. Reported revenue declined by $44 million, or 21%, to $171 million for the quarter. Excluding sales last year from the firm's beauty products, revenue was down just 18%. Year-to-date, adjusted sales are off 3%.
The shortfall resulted from soft sales at its outlet stores (off $12 million), continued economic difficulties in Asia where it gets 18% of its revenue ($6 million), a downward trend in athletic footwear ($6 million), and lower-than-expected margins on its excess inventory ($6 million) due to discounts as steep as 60%.
Donna Karan now expects FY98 revenues will dip to $610 million to $625 million from $639 million last year, making Idol's call for $1.5 billion in sales by 2000 look like idle talk. The latest guidance even assumes a new $5 million licensing fee will be booked this quarter. All that adds up to a break-even year versus the $0.30 per share analysts had been expecting.
With the worries accumulating, the stock got hit hard in the August market turmoil and has never really recovered.
BUSINESS DESCRIPTION
Donna Karan is a top fashion design house selling four seasonal collections of women's and men's clothing, sportswear, accessories, and shoes. Last year, wholesale accounted for 84.5% of revenue (women's wear for half of revenue), licensing royalties for 1.5%, retail outlets for 13%, and the rest from the now jettisoned beauty business.
The women's ready-to-wear apparel market is divided into five price levels: budget, moderate, better, bridge, and designer. The Donna Karan New York and Signature brands target the designer market while its bridge collection goes by DKNY. With the licensing deals, it now competes in the "better" segment as well.
In the last year, Donna Karan has signed licensing deals with Wacoal America for men's and women's DKNY intimate apparel, Esprit for DKNY children's apparel, Phillips-Van Heusen for DKNY men's dress shirts, Mallory & Church for DKNY men's ties and hosiery, Peerless Clothing for DKNY suits and sport coats, and Max Leather for belts and small leather goods.
In March, the company sold its remaining 30% stake in Donna Karan Japan (DKJ) to Onward Kashiyama, which will transition over three years to a licensing arrangement with DK. Japan accounted for 10.5% of FY97 revenue.
The company will soon have four new full-price U.S. retail stores. By year-end, it will have added 14 domestic outlet stores, for a total of 63, and 13 licensed international stores, for a total of 70.
Chair Donna Karan and her husband, Vice Chair Stephan Weiss, together control 24.3% of the shares.
FINANCIAL FACTS
Income Statement*
12-month sales: $630.6 million
12-month income: ($65.1 million)
12-month EPS: ($3.03)
Profit Margin: N/A
Market Cap: $147.3 million
*Includes numerous one-time charges.
Balance Sheet
Cash: $4.1 million
Current Assets: $202.2 million
Current Liabilities: $91.5 million
Long-term Debt: None
Ratios
Price-to-earnings: N/A
Price-to-sales: 0.23
HOW COULD YOU HAVE SEEN IT COMING?
Of Donna Karan's FY97 loss of $91 million, over $61 million can be chalked up to restructuring. That was massive and indicated that Idol was taking aggressive action (which Wall Street likes) and really reshaping the company. That's almost always harder that it initially seems. DK was also facing continued weakness in Asia, an important market.
Perhaps the surest sign of further trouble was new executive turmoil at DK. Mary Wang, president of the all-important DKNY women's division, left in May to join Emanuel/Emanuel Ungaro. Though Idol knew months earlier of her plans to leave, he apparently couldn't find an immediate replacement. Others jumping ship included Linda Beauchamp, president of the men's divisions, and Sonja Caproni, design director for the home accessories group.
Finally, the company announced plans to cut prices 15% to 25% on its DKNY spring '99 women's collection and 25% to 35% on its DKNY men's line while refocusing its design and merchandise mix and cutting the number of styles. All that was good news, but it meant the current inventory wasn't selling at suggested prices, and all of that merchandise needed to be cleared out.
WHERE TO FROM HERE?
After announcing the disappointing Q3 results, CEO Idol said Donna Karan was lowering its FY99 target to revenue of $610 to $650 million and earnings of $0.23 to $0.41 a share. Rather than end up a fashion victim, the analysts have toed the line with a $0.31 per share consensus estimate. Last summer, some analysts were looking for FY99 earnings of $1.00 per share!
The good news is that even with continued difficulties, Donna Karan's adjusted gross margins rose to 29.4% in Q3 versus 26.4% a year ago. Also, SG&A (selling, general and administrative) expenses dropped by 34% in actual dollars, to 20.9% of revenue from 25.3% last year. Cost-cutting is working.
Reducing the number of styles in the spring DKNY line to 250 from 450 a year ago will help. So, too, will cutting the number of factories it uses from 488 to 330 by spring and to 250 by the end of 1999. DK is also concentrating on helping department stores manage their DKNY "store within a store" area.
By 2000, Donna Karan hopes to have reduced its wholesale business to 70% to 75% of total revenues, with licensing providing 3% to 4% and retail about 25%. The goal is to increase menswear to 25% of total sales from 19% today.
The real opportunity for Donna Karan, though, is for DKNY to compete with the likes of Ralph, Tommy, and Calvin by offering more colorful clothes and mainstream prices. That will definitely prove a challenge. Still, with the stock beaten down, even gradual success could make DK a fashion forward investment.
Short term, though, Donna Karan might suffer from some tax-loss selling. Also, while inventories are much improved, there could be some more painful markdowns left as the company positions itself for lower price points.
-- Louis Corrigan
([email protected])
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