NEW YORK — The Ralph Lauren-Jones Apparel Group marriage of revenues and royalties is showing signs of strain.
Shares of Jones Apparel Group tumbled as many shareholders sold their positions following the firm’s announcement that there is a disagreement with Polo Ralph Lauren Corp. over the termination date of its Lauren by Ralph Lauren licensing agreement.
Included in the announcement was the suggestion that while the parties are in active negotiations over the issue, there was also a chance that Jones could lose the Lauren license after 2003, which would have a material effect on earnings and revenues in fiscal 2004 and beyond.
The issue came up last year during discussions about Jones’ failure to meet minimum royalty payments required in its Ralph by Ralph Lauren agreement. The company is trying to keep the license past Dec. 31, 2003, the current end date.
Meanwhile, Polo has contended that it has the right to end the more lucrative Lauren license at the end of 2003, three years earlier than its official expiration, because of the failure to meet minimums in the Ralph agreement. Jones said Tuesday it has a different interpretation of the agreements, and that it has the right to keep the Lauren license through the end of 2006.
According to Jones, sales of Lauren were $548 million and sales of Ralph were $37 million for the year ended Dec. 31, 2002. While income from Ralph has minimal impact on Jones’ bottom line, the loss of the Lauren license would have a “material adverse impact on Jones” at the operating level, after fiscal 2003, the company said. Jones emphasized that the loss “would not materially adversely impact Jones Apparel Group’s liquidity.”
Jones’ revenues in fiscal 2001 were $4.1 billion while Polo’s were $2.4 billion.
Polo said in its annual report for the year ended March 30, 2002, that its various licenses with Jones, including jeanswear, were responsible for about $65 million in royalties, about 26.9 percent of its corporate licensing revenue.
The disclosure came just one day before Jones is scheduled to report its fourth-quarter and full-year results for 2002 and two days before Polo chimes in with third-quarter results.
The disagreement does not affect the Polo Jeans license agreement held by Jones for sales in the U.S. According to Jeffrey Edelman, analyst for UBS Warburg, the Polo Jeans license generates about $400 million to $450 million in revenues a year.
Anticipating the worst case scenario in which Jones lost the Lauren license business, shares of Jones on Tuesday fell $2.57, or 8 percent, to close at $29.50 on the Big Board. At least 7.2 million shares traded hands on Tuesday, compared with an average daily volume of just 942,363 shares traded.
Peter Boneparth, Jones’ chief executive officer, said in a statement, “We disagree strongly with Polo’s belief that the two licenses are linked in this way. While we believe that a new long-term agreement arrived at by mutual consensus would be to the benefit of both our companies, given how well the Lauren line has performed under our stewardship, we are prepared to take all necessary steps to enforce our rights under the Lauren license.”
Nancy Murray, senior vice president for corporate affairs at Polo, said, “We believe Polo Ralph Lauren has the right under its [Ralph and Lauren] contracts with Jones Apparel Group to terminate its existing license agreements based on Jones’ failure to meet certain contract minimums. Notwithstanding that right, we are in negotiations with Jones regarding the possible continuation of our business relationship.
“We have had a good long-standing relationship with Jones. [However], we believe our rights are very clear and we are comfortable in our legal position.”
While Ralph is a business that was still in development, the Lauren line has been selling well at retail.
“The Lauren line is one of the best performing in sportswear and has been since the day they launched it. They’ve interpreted well-priced clothes for the better zone of business in the Ralph Lauren lifestyle,” observed Frank Doroff, Bloomingdale’s executive vice president of ready-to-wear.
Emanuel Weintraub, apparel consultant, observed, “These are two very powerful companies who fundamentally need each other. Jones has put a huge amount of money into the Lauren line, and done an awful lot to bring an enormous value and [dollar] amount to the bottom line. I hope they will work this out.”
Robert Drbul, analyst at Lehman Brothers, wrote in a research note: “At this point, it is still not clear when the dispute between the two companies will be resolved. While it is a fluid situation that could change at any point, Jones felt the two companies were far enough apart in the negotiations that it was important to update the financial community.”
According to Drbul, the $37 million in revenues from the Ralph license were “well below the minimum contracted amount of $100 million. The Ralph license was not profitable for Jones in 2002, as we believe the brand is positioned in an awkward segment of the market, too expensive for juniors and too junior for missy customers. The terms of the licensing agreement restrict Jones’ ability to effectively target either the missy or junior customer.”
Industry sources told WWD that there’s been unhappiness between the parties for some time. Executives at Polo deny any dissatisfaction with the working arrangement, while Boneparth during a conference call expressed a desire to continue the relationship. Yet, one bone of contention, financial and apparel sources said, is whether the Lauren line is indeed a mature business.
Boneparth said in previous quarterly earnings conference calls — and a point he reiterated in Tuesday’s call — that Jones doesn’t see Lauren as a “double-digit” growth driver going forward.
Sources close to Polo told WWD that executives at the designer’s company believe otherwise. That has led some in the industry to believe that Polo might be looking to take the license back and handle the production internally. Such a move probably would insert Jones into the sweepstakes to gain the Calvin Klein women’s wear license from Phillips-Van Heusen Corp., once its acquisition of Calvin Klein Inc. is completed.
According to Jennifer Black, analyst at Wells Fargo Securities: “My sense is that Polo wants to have the ability to control their destiny. When Ralph Lauren hears that Lauren is a mature business, I think that that isn’t what he’s thinking. The potential for Lauren is much larger than that. Controlling the brand’s destiny will enable Polo to have a cohesive look applied to all aspects of their business.”
UBS analyst Jeffrey Edelman wrote in a research note: “In our view, one has to question the motives of Polo Ralph Lauren as to whether or not they felt the original royalty agreement was too much in favor of Jones Apparel and thus now trying to use this opportunity as a bargaining tool. While we know Polo is interested in acquiring its licensees, we doubt whether or not it has the infrastructure or capability to run a business as large as the Lauren license.”
He noted that Jones’ management has been actively looking to “reinvest its cash flow into other brands with greater growth potential.”
Boneparth said during the call to analysts that the company’s desire is to “do a longer-term deal with the Polo Corp.” He also disclosed that the company “offered a substantially higher royalty than what we’re currently paying. We think we are extremely good operators. We’ve proved that. We have put on the [table to Polo] a substantially richer deal than what is in place.”
According to sources familiar with the negotiations, the upped royalty payment Boneparth referred to is higher than the sum of the current combined percentages for Ralph and Lauren. Whatever the number, it’s apparently an increase, albeit not one that has led to a resolution.
Black said because of “Ralph’s name, the company deserves to get a premium from their licensees.”
But just how much? The average licensing royalty is 5 to 6 percent. There was speculation in the financial industry that Jones offered 10 to 12 percent.
Executives at Jones did not return calls for comment, while officials at Polo declined comment on negotiations.