FTAR Makes it Official

Yesterday morning FTAR filled the long expected 8K stating that the KMart contract will not be extended beyond 12/31/08 which effectively means the company will wind down and cease to exist shortly after the end of this year. KMart will pay $13M for FTAR’s intellectual property (i.e. ThomMcAnn) as well as honoring the post-bankruptcy master agreement which stipulates that KMart will buy all inventory at book value. Also, the company will be terminating retiree benefits and life insurance which will remove $14.7M of long term debt from the balance sheet and result in a one time earnings gain.

This announcement essentially puts in writing what everyone already knows and makes the investment thesis even simpler. I have updated my figures ( for the most recent news and believe that at worst FTAR is worth $7 per share (up 45% from current levels) and at best $8.4 (up 75%).

[**I am still trying to figure out how to post Excel tables in Blogger so I will add my calculations for the $7 and $8.4 price as soon as I get a hang of this. If you have any suggestion on how I can do this other than posting a picture file that is all but unreadable let me know at offthebeatenpathinvestments@gmail.com]

The biggest difference between the worst and best case scenarios is my estimate of 2008 FCF generated by FTAR. In the worst case I assume sales down 10% over 2007 and some margin erosion while in the best case I assume flat YoY sales and slight margin expansion.

There could also be upside if FTAR sells its HQ for higher than book value, if the non-KMart business is worth more than $0, $80M in NOLs are worth more than I expect, and wind-down costs are less than I estimate.

FTAR currently represents 10% of the “Best Ideas Portfolio” (and roughly that much of my own account) and I plan on raising the stocks weight to 15%.

* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.

FTAR.ob -- 3Q Earnings Analysis

FTAR announced Q3 : 2007 earnings last week. Here is the quick breakdown of reported earnings

Q3:2007
Rev $148 (down 3.8%)
GP $44.2 (GM up to 29.9% vs. 29.8% last year)
EBITDA $7.2M (down from $7.7M last year, EBITDA margin down to 4.9% vs. 5% last year)

YTD 2007
Rev $455M (down 6%)
EBITDA $32.9M (up from $30.8M)

When I last wrote about the company I stated that

“next quarter I will be watching for the trend in SSS, K-Mart closings, and EBITDA margin improvement”

While it looks like the sales decline is slowing, there is still a sales decline with SSS at Shoemart down 1.8% and store closings of 0.4%. While it is disappointing I can’t say that I am entirely surprised taking into account the warm winter and consumer spending problems at the low end shopper.

The big disappointment for me was the decline in EBITDA margin. FTAR has been able to offset the decline in sales with continued operating improvements but it looks like they finally ran out of places to cut cost. Not even the best mangers can keep swimming against the tide of negative sales growth – looks like this is the first quarter where this has caught up with FTAR.

So …..sales are down, store count is down, warm weather means less need for new shoes, FTAR’s customers have less money in their pockets, and cost cuts are not keeping up with sales declines ……WHO CARES?

FTAR is still going to generate somewhere between $15M and $25M in free cash flow in Q4 of 2007 and another $30M - $60M in free cash flow in 2008. It will sell its headquarters for north of $20M and already has $15M in cash. With K-Mart having to buy all its inventory at book value at the end of 2008, FTAR is worth somewhere between $5 per share (worst case scenario which assumes some very bad developments) and $8 per share (best case scenario that is way bullish).

In the following quarter, my expectation is that sales well be down roughly 5%. The thing I will be watching is how badly EBITDA margins get hit. Will they continue to fall or will management continue to work its magic.

* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.

FTAR .OB-- 2Q Earnings Analysis

FTAR announced Q2 earnings today and filed the 8K, actually this company does not announce earnings to any of the major news wires.

Before I dive into the earnings analysis here is what I was looking for when I last posted on the company:

"I will be watching for in the next earnings report are the trend in SSS, trend in K-Mart closings, and Gross and EBITDA margins."

I would say that the latest quarter was mixed but with more positives than negatives.

Looks like overall sales were down 9% YoY with SSS at Shoemart (these are the K-Mart stores that make up 98% of revenue) down 8% with Rite-Aid reporting a horrific 14.5% decline. Looks like no Shoemart stores were closed in the quarter which is good news. For the first six months total sales are down 5%.

The company blamed weak Easter and poor April sales...blah, blah, blah. When I initially posted on the company I used a 10% sales decline as the "Worst Case Scenario" assumption. If things continue at this trend we may hit that worst case scenario.

However, the rest of the report was nothing but good news.

Gross margin was up 80bps to 35% in the quarter and up 90bps to 33% for the first 6 months. This is tracking ahead of my "Best Case Scenario" assumption of 50bps improvement in GM.

SG&A expense fell more than revenue declined providing 50bps increase in margins for the quarter. For the the first six month SG&G as % of revenue is at 24.7% for a 30bps improvement. This is improvement is more or less in line with my Best Case scenario assumptions.

The margin improvement provided for positive EBITDA growth of 1% to $23.6 negating the 9% sales decline. EBITDA is basically free cash flow for FTAR since it does not pay taxes, have any debt, or CAPEX.

If the company can continue to offset sales declines with margin improvements, I believe my previous target price range of $3.5 - $7.5 per share is still valid and provides substantially more upside than downside at current price levels. As I mentioned before, the free option on the contract extension with K-Mart becomes less valuable with each passing day and I have personally assigned it a zero dollar value at this point.

Again, next quarter I will be watching for the trend in SSS, K-Mart closings, and EBITDA margin improvement.


* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.

FTAR -- Selleing HQ

It looks like FTAR has put its headquarters up for sale accoriding to a link on Google Finance. I missed this as I almost never use Google Finance.

This story was not reflected on my Reuters station and I am almost certain not reflected by Bloomberg but will have to double check on Tuesday. I just searched the 10Q reported 1 day before this story ran and can find no mention of this. Checked all the 8-ks since the begining of the year, nothing. This seems rather odd and leads me to the following thoughts.........

If the good people at globest.com report that FTAR is selling their HQ and no one hears it, did it really happen? http://www.globest.com/news/903_903/newjersey/160542-1.html

More importantly, the sale of the headquarters will provide 2 key data points that are going to shed substantially more light on my bullish thesis for FTAR. First, I used $16.5M for the value of this building in my liquidation value analysis which translates to $0.80 per share. They may sell it for more or less than I estimate but it will make at least one uncertainty certain.

Second, the terms of the sale will be a huge clue as to what is likely to happen with the K-Mart option. If its a sale leaseback agreement with a long duration I think this is a big clue that there maybe an agreement coming down the pipe. If this is an outright sale with FTAR moving out in late 2008 or early 2009 than I think the K-Mart option goes to way way way way out of the money (from the current level of way way out of the money).

* DISCLOSURE: I or accounts I manage are long FTAR.OB. This is not a recommendation to buy or sell any security. For informational and educational purposes only.

FTAR.OB -- Final Thoughts

In the previous 4 posts I have outlined the bullish and bearish case for FTAR. As a final thought I will spend some time on short term catalysts that have made the stock even more attractive and have caused me to add to my position recently.

First, management has removed a lot of uncertainty by issuing a special (hopefully not) one time dividend that was paid at the end of April ….oh yeah!, daddy needs a new pair of K-Mart shoes. By the way, if you are looking at financial statements subtract roughly $105M from cash on hand, the small shortfall is going to be financed by the line of credit that will be paid of with this years cash flow.

The biggest concern prior to the special dividend announcement was about management’s intention for the boatload of cash on the books and cash being generated. I think this concern has largely been removed and a liquidation scenario with all cash going to shareholders is a real option. FTAR was trading at $6.5 before the announcement of the dividend and adding back the $5 per share now trades at $9.6 so the dividend payout has removed a lot of overhang and moved the shares by 50%.

Also, the new management team has done and outstanding job streamlining the business which has cause EBITDA margin to increase from 4.5% when the company started trading again to 8.1% over the last 12 months (see Bull case Part I for additional margin discussion http://offthebeatenpathinvestments.blogspot.com/2007/05/bamm-da-bulls-part-i.html

Third, while I don’t want to read into the latest quarter to much since it’s the weakest quarter for the company it looks like the company is continue to improve and at an increased pace. As mentioned in the earlier post, SSS finally have a plus sign in front of them and Rite-Aid SSS were up over 4% with store count up slightly.

Gross Margins were up 130 bps YoY (again, this is huge for a company that had EBITDA margins of 8.1% last year), but keep in mind that the first quarter has the lowest sales and lowest margins so even small changes look big. Also, SG&A expense decline again and SG&A as % of sales improved by 50bps. All in all this was a pretty outstanding quarter, if this company had analyst coverage they would have reported a huge earnings beat.

My last point is more anecdotal but there are some things I have noticed in the 4 months I have owned the stock that put a smile on my face. For example, the annual report I received was on cheap black and white paper stapled together rather than an expensive book – this is good! Another example is that the company just announced a great quarter by any measure and they did not even put out a press release so none of the major alert services picked it up -- just a filling and that’s it. In a case like FTAR where they are going to be holding my cash for a while, these are all things that make me sleep better at night.

Things I will be watching for in the next earnings report are the trend in SSS, trend in K-Mart closings, and Gross and EBITDA margins.

* DISCLOSURE: I or accounts I supervise are long FTAR.OB. This is not a recommendation to buy or sell any security. For informational and educational purposes only.

FTAR.OB -- “Da Bears”

Of course FTAR faces the same economic sensitivity problems that any consumer discretionary company faces.

The company may also not be a “long term” holding in that it may not be there after 2008 – but that’s one of the bullish scenarios.

To a certain extent the company does not control its own destiny. They are always going to be dominated by someone else who owns the stores they sell their products in. As department stores and discounters consolidate they will have more clout to get better revenue sharing agreements out of FTAR.

To a certain extent they operate in the commodity business of selling cheap shoes. They do own some brand names but I have never heard of them and would not assign much value to discount brands sold at the “bottom of the pile” retailers.

* DISCLOSURE: I or accounts I supervise are long FTAR.OB. This is not a recommendation to buy or sell any security. For informational and educational purposes only.

FTAR.OB -- “Da Bulls” Part II

Picking up where I left off in Part I, in addition to the better upside odds than downside FTAR also comes with a FREE call option that expires in the end of 2008.

Per the agreement with K-Mart, FTAR can be fired by their largest client in the end of 2008 which would cause the liquidations scenario I described in Part I. However, if K-Mart decides to extend their relationship FTAR now becomes a going concern generating roughly $20M and $40M in annual free cash flow.

Simply attaching a 10x multiple to that cash flow (which assumes tax expense), adding back the PV of the NOL’s that are now worth more as they will be realized and subtracting the long term liabilities I get a market value of $270 - $450 which equates to $13 - $22 per share. This value excludes some hard assets and other assumptions made under the liquidation scenario ….. but who cares, if I am off by a dollar or two at this level its still a damn good return.

* DISCLOSURE: I or accounts I supervise are long FTAR.OB. This is not a recommendation to buy or sell any security. For informational and educational purposes only.

FTAR.OB -- “Da Bulls” Part I

Before moving on to the rest of my post, the one sentence bullish thesis is basically that the agreement with K-Mart and the recent actions by management have provided for a limited downside with a fairly good possibility of positive absolute returns as well as a free 1.5 year option that is likely to expire worthless but can turn FTAR into a 3-5 bagger between now and end of 2008.

I am going to do my best to turn my spreadsheet into words but I suggest e-mailing me at offthebeatenpathinvestments@gmail.com and requesting a copy and double checking my figures (and letting me know if I made a mistake). To get to my price range of $3.5 - $7.5 I made some “worst case scenario” and “best case scenario” assumptions. By the way if anyone knows how to post excel spreadsheets into Bloger let me know.

In my Worst Case Scenario I am assuming that
1) sales fall 10% in 2007 and 2008,
2) gross margins decline in 2007 by 100bps from 2006 levels (100bps decline in gross margins is HUGE for a company with EBITDA margins of 8.1% in 2006) and stay the same in 2008, and
3) SG&A expense falls only 3% YoY, basically I am assuming that for a compounded decline of 21% in sales over next 2 years, SG&A only declines 6.1%

Bearish indeed …….
Those of you that actually look at the recent financials will say that a 10% YoY decline in sales does not sound very bearish when you consider recent trends in sales. I will point out that FTAR’s K-Mart business SSS (same store sales) have improved substantially with SSS in 2006 at negative 3.8% and SSS in 2005 at negative 7.5. Also, SSS were actually positive in Q1-2007 with +0.7%, however this is the company’s weakest quarter so it may not represent a trend.

Another reason why I think total and SSS will not be similar to the most recent past (and therefore a 10% decline would represent a Worst Case Scenario) is that K-Mart has gone through a re-org of its own and I am sure Eddie Lampert closes his worst performing stores first just like anyone else. Also, the actual number of FTAR’s K-Mart stores declined by 3 in Q1-2007 on track for 12 closed stores for the full year. In 2006 FTAR lost 29 K-Mart stores and in 2005 they lost 61.

In my Best Case Scenario I am assuming that:
1) total sales stay flat in 2007 and 2008 -- actually this is an assumption that SSS will be positive as its likely that there will be a number of K-Mart stores closed in that time, and
2) Gross margin increase by 50bps in 2007 and 2008 for a compounded increase of 1% over next 2 years, and
3) SG&A expense will fall by 1.5% in 2007 and 2008 for a compounded decline in SG&A expense of 3% on flat sales

While these assumptions are certainly bullish, they are not impossible. For example, on a rolling 12 month basis GM has increased in each of the last five quarters from 31.5% to 32.2% (again a 70bps move is huge for a company with EBITDA margins of 8.1%). Furthermore, SG&A as % of sales has fallen in each quarter from 26.5% to 24.1%.

Under the worst case I get FCF (assuming $2M in capex annually) of $30M and $16M which are worth $40.5 today discounted at 10%. Under the best case I get FCF of $59M and $61M which are worth $103.5 today.

But that’s not all folks, you also get all your inventory taken out at BV (not liquidation fire sale value) which I calculate as being worth $33M discounted at 6%. To get this I simply net A/R + Inventory against A/P and Accrued Expenses and discount.

If you call now, you will also get the estimated value of the non-K Mart business which is growing by the way, the company headquarters that are almost all paid for and the value of the NOL’s that FTAR has. Net out the liabilities as well as my estimate for $10M-$15M in liquidation costs and I get a price range of $3.5 - $7.5 per share.

At current trading price of $4.6 you get downside of 23% for upside of 64%, those are 3 to 1 odds from where I come from.

* DISCLOSURE: I or accounts I supervise are long FTAR.OB. This is not a recommendation to buy or sell any security. For informational and educational purposes only.

FTAR.OB -- First Look

Initially looked at the stock in February 2007 for several reasons:
-recently emerged from bankruptcy with no debt and approximately ½ of the market value in cash (before the recently announced speical dividend)
-eps is roughly $2/sh while the stock is trading between $6 - $7 per share (before dividend was paid out)
-originally written up on valueinvestorsclub.com

Currently:
Share Price: $4.60
Market Value $96 million
Enterprise Value: $110 million
Investment Type: Special Situation


Footstar (FTAR) operates footwear departments at lower end stores with the company’s K-Mart business representing over 90% of sales -- if you buy shoes at K-Mart’s serviced by FTAR you are buying them from FTAR not K-Mart. Per the latest 10Q (filed in May 2007 http://www.sec.gov/Archives/edgar/data/1011308/000095012307007054/0000950123-07-007054.txt) the company currently services 1,389 K-Mart stores and 857 Rite-Aid stores. The company also operates a wholesale business which consists of owned brand names (Thom McAn, etc.) and generics which are supplied on a wholesale basis to Wal-Mart and Rite-Aid.

At this point FTAR represents a special situation investment with the likely termination date of 12/2008. As part of the recent re-org (in which FTAR paid out 100% of its debt obligation and did not dilute share count) as part of the bankruptcy re-org, FTAR ended up with 100% of Meldisco (previously a JV with K-Mart) but K-Mart is only required to do business with FTAR until the 12/2008. When the contract runs out, K-Mart can end its relationship with FTAR or renew the contract. If K-Mart ends the relationship it has to buy out all of FTAR’s inventory related to its stores at book value – since K-Mart is 90% of FTAR’s business essentially all its inventory is K-Mart related.

The investment opportunity really hinges on inventory buyout in the K-Mart agreement. Based on present value of the estimated cash flow that FTAR will generate until 12/2008 and the value of the non-K-Mart businesses I believe the stock is worth somewhere between $3.5 – $7.5 (more about my calculations in the next post). However, as an investor in FTAR you also get a free option on FTAR signing new agreement with K-Mart at which point FTAR would no longer trade at liquidation level valuation of 2x-3x cash flow and would be worth somewhere betwee $13 - $22 per share (more about my calculations in the next post).

* DISCLOSURE: I or accounts I supervise are long FTAR.OB. This is not a recommendation to buy or sell any security. For informational and educational purposes only.