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Bottom of the Barrel: No Bed of Roses at Martha Stewart

As the diva's problems linger, the company feels the pinch.

The petals may be falling off the rose at

Martha Stewart Living Omnimedia

(MSO)

.

This morning's conference call seemed like a clear indication that the domestic diva's travails are finally catching up to her namesake company. Sounding almost defeated, the usually upbeat chairwoman said she had no idea when her company might bloom again.

"During our last earnings teleconference this past March, I expressed that I was increasingly hopeful that my personal legal situation regarding the ongoing governmental investigation of my sale of noncompany stock would be resolved in the near future," Stewart said. "Obviously that has not happened, and I can make no predictions as to when it will."

Stewart went on to suggest that she may have become a liability to the company. "Our business results for the quarter reflect considerable pressure associated with the continuing investigations," she said, noting that the damage may linger long past any finding of guilt or innocence. "Once the investigations are resolved, we will be in a better position to assess the appropriate steps necessary to achieve improved financial results."

Droopy

Investors weren't cheering when they saw the first-quarter results, a loss of 9 cents per share on revenue that declined about 15% from the year-ago quarter. The stock certainly didn't respond well to Stewart's comments or those of CFO James Follo, who broke the bad news that the second quarter was likely to result in a per-share loss of 3 cents to 5 cents. Analysts were expecting a nickel profit in the quarter ending June 30.

"Consolidated revenues are expected to decline approximately 20%" in the quarter, Follo said on the conference call. That includes a weak publishing segment and 30% revenue declines projected from the

Kmart

relationship.

TST Recommends

Publishing revenue was generally weak, as was retail, as Kmart closed an additional 300 stores. Although Martha Stewart has a minimum revenue contract with Kmart for 2003, royalty revenues may come in well below the 2003 minimum levels. However, with Kmart's bankruptcy, it isn't clear how the shortfall will be handled. Martha Stewart says it will record the difference between actual revenues and the minimum level in the fourth quarter, and Kmart theoretically would make payment on the shortfall in 2004.

What is most worrisome about the first quarter -- and suggests significant fallout from both customers and readers -- is the implosion at

Martha Stewart Living

, the company's flagship publication. On the conference call, Follo noted that advertising revenue declined -- gulp -- 35% in the quarter when compared to 2002, and circulation revenue slipped 20%. The economy might explain part of the weakness, but the comments from Stewart combined with the magnitude of the decline suggests the tarnished image of the company's founder is catching up with the company.

Asset or Liability

While Stewart herself continues to have her share of loyal fans, their number is clearly shrinking. Some defectors may return if Stewart is ultimately innocent, but the bigger worry is that some former subscribers have simply lost interest, never to return. The longer the probe lingers, the more risk of losing them forever.

More tangibly, Stewart has become a liability to the company's balance sheet. On the conference call, the company said it spent $1.2 million in the first quarter related to the chairwoman's travails. It has not only cost the company cash; it has also impacted the company's ability to defend its stock price through buybacks.

When asked if the company would consider stock buybacks until the probe was settled, Follo was clear: "I think it's likely that we will remain on the sidelines until we have resolution with anything with respect to our shares."

The uncertainty is also clearly affecting employees and morale, and, more important, it may be getting under the skin of senior executives. When a question was lobbed to Follo and President Sharon Patrick about the challenges facing the business, Follo attempted to talk about the weaknesses at Kmart and in publishing.

However, a direct Patrick suggested the company's problems could be traced back to one person: Martha herself. "I would say the single biggest factor that's affected our performance is the lingering lack of resolution of the Martha situation that impacts every aspect of our business," Patrick quipped.

It's not all smiles at Martha Stewart's shop. In fact, unless clarity comes soon, Martha and her shareholders may be facing a bed of thorns.

Christopher S. Edmonds is vice president and director of research at Pritchard Capital Partners, a New Orleans energy investment firm. He is based in Atlanta. At time of publication, neither Edmonds nor his firm held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to

Chris Edmonds.