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Friday, March 26, 1999

The North Face, Inc.
(Nasdaq: TNFI)
Phone: 970-704-2300
Price (3/25/99): $13 3/4


1999 has been one bizarre year for investors holding on to The North Face (Nasdaq: TNFI). After seeing their stock descend from a February 1998 high of $29 per share to as low as $9 3/8 in the last week of the year, worries about the company's rising receivables and inventory started to come to a head. Would the short sellers be right? Would the rumors about the nefarious channel stuffing by the company prove true?

The shares rose slowly over the first two months of 1999 as worries about the company's fortunes calmed a tad. Then, on the first trading day of March, a fuse was lit under the stock. The company's board announced it was going to take the company private in a management-led leveraged buyout (LBO) with the merchant banking firm of Leonard Green & Partners. The buyout offer dangled in front of shareholders was $17 per share in cash, a sizable premium to the $12 7/8 the stock closed at before the announcement. Needless to say, the stock rocketed forward the next day, up nearly 30% on ten times normal volume.

Unfortunately, the stock's ascent didn't leave much time to enjoy the view from the peak. Less than a week after the LBO was announced, The North Face retracted its tender offer, saying that it was "experiencing unexpected delays in preparing its audited financial statements for 1998, the resolution of which may also impact the Company's 1997 audited results." Even though portions of the LBO mechanism remain in effect, the shares were pounded as low as $10 7/8 in another huge-volume day of trading. In an amazing week, the joys and gains the a buyout announcement on Monday were completely wiped out by the following Friday.

The story doesn't end there. The next Thursday, March 11, Nasdaq halted trading in the shares for the entire day after it was revealed that the company's auditors were, in fact, going to force the company to restate results for the fourth quarter of 1997 and the first quarter of 1998. After more information was disclosed at the stock exchange's request, the shares resumed trading the following day and were pummeled down as low as $9 1/4. The class action lawyers were gathering and growling.

North Face shares have since regained some of their lost altitude, but still remain far below their annual high, more than qualifying the company for the Daily Trouble.


The North Face is a manufacturer and retailer of equipment and clothing for outdoor activities. The company's wide product line includes everything from tents, to ski pants, to jackets -- all sold under The North Face brand name. Most of the products are geared towards those willing to pay a higher price for a branded item with higher perceived quality.

Founded back in the 1960s, the company has changed hands several times and came public in 1996. The North Face recently moved its corporate headquarters from California to the mountains of Colorado to "keep in touch" with its mountaineering roots.


The company's 1998 financial results are currently being audited and will likely be revised

Income Statement
12-month sales: $263.3 million
12-month income: $9.5 million*
12-month EPS: $0.76*
Profit Margin: 3.6%
Market Cap: $176.7 million
(*Excludes one-time charges)

Balance Sheet
Cash: $14.2 million
Total Assets: $250.9 million
Current Liabilities: $96.1 million
Long-term Debt: $12.8 million

Price-to-earnings: 18.1
Price-to-sales: 0.7


Looking back, those who questioned the company's swelling receivables and inventory seem to have had the troubling story nailed long before the hoopla of this month. Having inventory and receivables grow faster than sales is often an indicator of trouble, and people watching these important items on the balance sheet saw the rocks beneath the surface before jumping in head first.

Even if one wasn't looking at the balance sheet, the increasing prevalence of exclusive The North Face branded products at high-volume, deep-discount outlets such as Sam's Club, owned by Wal-Mart Stores (NYSE: WMT), and Costco (Nasdaq: COST) should have raised questions. It was a strong clue that perhaps the company was producing a bit more than its traditional high-end market could devour.

William Simon, the company's CEO when most of the accounting shenanigans were rumored to be happening, filed for personal bankruptcy in 1994. This bankruptcy came soon after Odyssey Holdings, the former parent company of The North Face, went belly-up -- with Simon and North Face's current chairman, Marsden Cason, at the helm. Now there is a new CEO running the company, but upper management's reputation has suffered.


Accounting problems are like cockroaches -- they rarely travel alone, and seeing one is nearly a guarantee that there are dozens of others around that can't be seen. Although the actual restatements the auditors will likely request look to be relatively minor (less than 3% of trailing sales), the fact that the auditors are forced to do this in the first place is like seeing that lone roach scurrying across the floor. Investors are left to wonder if the audit will exterminate all the bugs and what other problems may lie out of sight.

The reasons The North Face got into trouble illustrate the classic marketing conundrum for companies operating at the high-end of the retailing spectrum. That is, how do you maintain a brand's exclusive reputation while selling into the mainstream market where most of the money is? Selling solely to specialty stores severely limits volume, while distributing widely tarnishes the brand's image. It is a balancing act that the company has obviously yet to master.

It's nearly impossible to analyze The North Face from a fundamental financial perspective here, since the true trailing results have yet to be disclosed and a final and conclusive determination may be far off. That leaves current investors to weigh the prospects of the CEO-led buyout actually occurring. After seeing the audit and completing their own due diligence, those lending the money for the LBO may have second thoughts. The company insists the process is moving forward, but the wide spread between today's stock price and the $17 buyout price indicates that Wall Street is doing anything but taking North Face's word at face value.

Regardless, this story is far from over, and only those with a highly adventurous streak should be interested in The North Face shares today.

-- Paul Larson

Related articles:
-- The North Face Privatized, Lunchtime News (3/1/99)

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