Bankruptcy Filing in Liz Claiborne's Future?

William McComb, Chief Executive Officer of Liz Claiborne Inc., predicted on the fourth-quarter 2008 earnings call that the fashion company, whose store labels include Lucky Brand, Kate Spade, and Juicy Couture, will keep losing money in the first half of 2009 as it confronts--like most apparel retailers--a severe pullback in consumer spending. Management protestations to the contrary, a review of the company's recently filed 2008 annual report with the SEC suggests that weak business prospects combined with a high debt load and restrictive loan covenants could sink the fashion company in the second half of 2009.

Although management has reduced its 2009 capital budget to a range of $60 million to $70 million (from $194 million last year, eliminated eight percent of its work force, and suspended its cash dividend, the company ended 2008 with total debt of $744 million, giving it a a total debt to total capital ratio of 59.6 percent (up from 36.9 percent in 2007). Entering 2009, the company's debt coverage ratio--or the amount of cash needed to meet annual and principal payments on debt--was 0.84, which means there is only enough operating income (before depreciation and taxes) to cover 84 percent of its existing debt obligations.

Straining liquidity, too, net cash flow was $(26.1) million in 2008, cash on hand at January 3, 2009 was just $25.4 million, and the company has $546 million in contractual cash onligations (including operating and capital leases, inventory purchase commitments, and borrowings) coming due this fiscal year.

Although Liz Claiborne successfully renegotiated with its lending syndicate less than two months ago, eliminating two covenants (leverage and asset coverage), the company must still maintain a fixed charge ratio--on a rolling 12-month basis--that exceeds 1.25 times the ratio of consolidated EBITDA (less capital expenditures) divided by fixed charges. The revised borrowing agreement gave the company access to $600 million in liquidity, of which $160.8 million remains unused. Excluding capital spending, the company is comfortably in excess of the requisite ratio.

Given the lack of visibility caused by this uncertain environment, CEO McComb did not provide full year 2009 EPS guidance. However, assuming a retail environment similar to the fourth-quarter of 2008 throughout 2009, McComb said the company would likely produce comparable same-store declines in the 15-25 percent range for all brands through [at least] the third quarter of 2009. In terms of operating profit, he believes cost initiatives and pricing and promotional strategies will lead to improving sell-through rates and positive reported adjusted operating profit for the second-half.

As most of the company's key distributors, such as department-store operator Macy's, are struggling to stay relevant--and solvent--in this weak economic environment, too, it is debatable that the fashion company can grow sales this year. Should shoppers stay away, and operating losses continue into second-half 2009, bankruptcy might be the only option left for the company founded by the venerable fashion designer Liz Claiborne in 1976.