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It wouldn’t be a LIZ call without plenty of puts and takes, but the bottom-line is that our thesis remains unchanged on the name. At this point, it’s all about execution. That will ultimately determine whether this is a $10, or closer to $20 stock 12-18 months from now. Either way, we think LIZ is headed higher.

Generally speaking we got the added color we were looking for on the conference call regarding several items that we called out earlier – we’ll hit on that in a minute. Our overall take on the quarter is that sales and segment margins are coming in better with more wood to chop on corporate overhead than expected. Coupled with uncertainty regarding the timing of debt reduction, we expect this process to be choppy near-term, but think the visibility of F12 and F13 EBITDA remains greatly improved and highly attractive on an annual basis.

We’re taking up our top line growth forecast by 2% to 14.5%, though we’re also taking up costs needed to secure the growth. Netting those two out, our numbers are down modestly (to EPS of $0.36 and $0.73 and $155mm and $215mm in EBITDA for this year and next year, respectively). We NEVER like a downward revision – but in a market like this where investors are paying up for stories that have rapid underlying growth with strong visibility, we’re going to give LIZ a bit of a pass. That’s especially when our estimates remain 2x consensus in the outer years.

Here are the key highlights from the quarter:

  1. Direct Brands: Kate and Lucky continue to press forward with both Q3 and October sales coming in strong. In fact, management got incrementally more bullish on both increasing the long-term outlook for Kate margins to high-teens to low-twenties (from 15%-20%) and margins at Lucky noting they expect to turn profitable for the year in Q4. In addition, the company is accelerating store growth at Kate by another 10%-20% to 20-25 in 2012. Given that Kate accounts for over 50% of EBIT this is exactly where you want to see incremental investment. Juicy came in a little lighter than expected in October. Since we aren’t expecting any real turn in sales until the 1H of next year when new product hits shelves – we’re not overly concerned.
  2. Partnered Brands: With assets sold rolling off and the DKNY license expiring at year-end, this segment is quickly consolidating to a base of ~$20mm in revs per quarter. It will be closer to $60mm in Q4 for the aforementioned factors, but the margin profile is coming in better than expected. Instead of the 10-12% margins we were modeling, on a go forward basis this business is going to have a margin profile in the mid-teens.
  3. Corporate Expenses: This was an incremental negative in the quarter. As it turns out, the corporate expense line is currently $70-$75mm, which the company intends to work down to $40-$50mm over time – more than we expected. By the end of F12, the company expects to have corporate overhead down to $55-$60mm with ~$15mm earmarked for next year. Roughly $10mm is associated with Mexx, which we expect to be cut on the front end resulting in corporate expenses of ~$60mm for F12.
  4. CapEx: Given the consolidation in sales, we expected CapEx to come in around $50-$60mm in F12 following ~$60-$65mm of CapEx in F11. Instead, the company is taking CapEx up to $70-$75mm next year to drive store growth as well as e-commerce and IT systems. At ~4.5%-5% of sales, this would represent the highest level of capital spending in company history. While a slight negative for F12 FCF, this has positive implications for revenue growth 2-3 years out.
  5. Debt Reduction: There is still uncertainty regarding the exact timing of when the company is going to settle either the Eurobond or convert. As such, we expect continued earnings volatility near-term until the Eurobond is settled, which is still the company’s first priority.
  6. Net Operating Losses: The updated loss carry forwards the company will have on its books by year-end is $200-$250mm, which LIZ can use as a tax shield for next few years.

All in, we’re adjusting our numbers to reflect higher sales growth of 15% in each of the next two years while also accounting for higher corporate expense. As a result, we’re reducing our EPS estimates by ~$0.10 to $0.36 and $0.73 in F12 and F13 respectively and EBITDA by ~$15mm to $155mm in F12 and $10mm to $215mm in F13. Using a blended 8x multiple, we’re still looking at a mid-teens stock. At this point, it’s all about execution. That will ultimately determine whether this is a $10, or closer to $20 stock 12-18 months from now. This remains at the top of our long list.

Casey Flavin

Director