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Daily Trouble
Fruit of the Loom, Ltd.

Ticker: (NYSE: FTL)
Phone: 312-876-1724
Website: www.fruit.com
Price: $4 3/16 (9/13/99)

By Paul Larson
Tuesday, September 14, 1999


How Did it Find Trouble?

Is that apple on the label rotten to the core? That's the question many investors are left to ponder as Fruit of the Loom has experienced more than its share of trouble. The stock traded above $40 per share in early 1997 and in the mid-teens early this year, but the company has seen its share price sheared down to the single digits as operational and financial difficulties rocked the company. In short, Fruit of the Loom has had its grapes plucked, and investors have thrown the stock in the hamper.

After several years of extremely spotty profitability, the company reported three straight quarters of red ink. The most recent quarter saw a loss of $0.03 per share versus profits of $0.90 in the same period last year as production snafus and customer service problems sapped profitability.

The latest round of problems started when the company filed its quarterly 10-Q report with the SEC in late July. In the document, Fruit of the Loom disclosed that it might violate some of its debt covenants in the third quarter if operating results didn't turn around.

This warning took on deep significance on August 30. After the closing bell on Wall Street that day, the company issued twin announcements -- that its longtime CEO and President, Bill Farley, was stepping down (but staying on Fruit's board of directors) and that it would likely miss its forward profit estimates by a wide margin. More importantly, it became clear that the company is not likely to be in compliance of the terms of its debt covenants -- not exactly a peachy situation.

Soon after the earnings warning, both Moody's and Standard & Poor's downgraded their opinions about the quality of the company's outstanding debt. S&P didn't actually change its ratings, but put the firm on "Credit Watch with negative implications," citing the production and customer service difficulties as reason for concern. Moody's, on the other hand, went ahead and cut its already fairly low ratings on a variety of the company's bonds. Moody's reiterated many of the S&P's concerns and also raised the issues of debt compliance and the vacancies at Fruit's top ranks.

While dramatic one-day drops in the stock have been comparatively rare, the extent to which this former blue-chip has fallen is nonetheless quite frightening.

Business Description

With domestic headquarters in Chicago (and a newly formed parent company based in the Cayman Islands), Fruit of the Loom is a major producer of a variety of clothing products. Those products include underwear, activewear, and children's clothing sold under a diverse number of brand names including Fruit of the Loom, BVD, Gitano, and Underoos.

Fruit of the Loom is a member of the S&P 500 index.

Financial Facts

Income Statement
12-month sales: $2,045.5 million
12-month income: $28.1 million
Profit Margin: 1.4%
EPS: $0.39
Market Cap: $280.1 million

Balance Sheet
Cash: $19.6 million
Current Assets: $1,020.9 million
Total Assets: $2,399.4 million
Current Liabilities: $393.3 million
Long-term Debt: $1,484.5 million
Total Liabilities: $1,949.5 million
Shareholders' Equity: $449.9 million

Price-to-earnings: 10.7
Price-to-sales: 0.1


How Could You Have Seen it Coming?

One way to have perhaps spotted the rotting in Fruit of the Loom was to look at the historical financial results of the company. Profits in 1994 and 1996 both gave way to significant losses in 1995 and 1997. The trend looks to be in place this year, since 1998 saw the company earn $1.88 per share, but this year the company is on track to end up in the red. Looking at the long-term history, investors may have seen 1998's profits as cyclical.

Probably the largest warning sign with Fruit of the Loom came from the company's balance sheet. The firm has nearly $1.5 billion in long-term debt and nearly $2 billion in total liabilities. This is not exactly a sign of a cash king. In general, leverage reduces the margin for error of equity investors as well as the company. And, when a company with lots of debt hits a rough spot like Fruit has, the problems can be greatly exacerbated.

The company also spelled out its problems with its debt covenants in its most recent 10-Q, at a time when the stock was nearly double the value it is as of this writing. Where the disclosure by Fruit was essentially buried in the document (the end of the fifth page of notes to financial statements), anyone reading the warning would have probably thought twice about owning the debt, much less the stock. It often pays to read any given firm's SEC filings closely.

Where to From Here?

One thing that is not in doubt about the company is the strength in the Fruit of the Loom brand name. Fruit does have a brand that is fairly well known across a wide section of the population and also has a fairly good reputation with consumers. But, then again, the underwear business isn't exactly a growth business, and the company has had a difficult time in recent years turning its marketing strengths into bottom-line dollars. It's uncertain when the company will be able to fix the operational problems that have plagued its profitability.

Fruit of the Loom is also a ship lacking strong leadership at its helm. When Bill Farley stepped down, the company lost its CEO, President, and COO all at the same time. The company has filled the positions temporarily, but rarely do interim executives have the power to make the radical changes that are obviously needed within Fruit of the Loom. It also looks like these positions will be filled later rather than sooner, since the departure appeared to be fairly sudden.

There's also the issue of the debt covenant violations. The company said it would likely be in violation of some of its covenants at the end of the third quarter, which may put the firm in default with some or all of its debt. If this happens, Fruit will be forced to renegotiate the terms of its debt, and there's no assurance that the company will come to an agreement with its lenders that won't hurt shareholders. A default may be like that first domino falling on the way to a fairly significant liquidity crisis. It's always important to remember in such situations that bondholders and lenders have first claim on assets, and shareholders are forced to stand in the back of the line.

Where Fruit of the Loom may eventually become a turnaround play, buying the stock right now is risky given the likely covenant violation. Any violation may actually bring bankruptcy into the realm of possibility. Fruit of the Loom will survive as a company if this happens, but not before the firm's lenders are appeased and shareholders see their percentage ownership in the company diluted. In short, Fruit is in a rotten position that doesn't look to get better any time soon.

Related Articles
News World - Fruit of the Loom in Sticky Situation (8/31/99)

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