Kenneth Cole may be out as CEO

(Fortune) -- Kenneth Cole took his company to the top of the fashion heap with clever advertising slogans like "To be aware is more important than what you wear," only to watch his business stumble.

Now there are signs that Cole, the company's chairman and chief executive as well as a notorious micro-manager, may finally be ready to step aside and relinquish day-to-day control to a more seasoned executive, though he would remain in an oversight role. A search is currently underway for such a person, and at least one major department store executive has been contacted about the job, Fortune has learned.

Anyone interested in filling Cole's shoes would face several hurdles. With sales flagging, the company, which makes shoes, handbags and clothing, is in the midst of a major repositioning, and it's far from certain whether the changes will pay off. Early results are not promising.

Attempts to upgrade the flagship Kenneth Cole New York line and make it more luxurious have not resonated with customers. And now the company is taking on its biggest challenge yet: After years of outsourcing production of its clothing lines, Kenneth Cole has taken all but one of the licenses back and will begin producing the labels in-house, a strategy that carries tremendous risk.

Perhaps the biggest hurdle is Cole himself. The founder and controlling shareholder is known for concerning himself with the smallest details, down to the height of a heel or the length of a skirt, sometimes to the company's detriment. His interference often made it difficult for managers to do their jobs, and contributed to the current void in the executive suite, sources said.

Joshua Schulman, the company¹S most recent president, left in July after six months. Though his predecessor Paul Blum held his post for 15 years, "he was president in name only," one source said. Cole declined to be interviewed for this story.

"Kenneth Cole is a brilliant marketer, but he's not a designer," said Harry Bernard of the consulting and executive search firm Colton Bernard. "His involvement in so much of the design process has created a lot of problems for the company."

Cole got his start in the shoe business, working first for his father's company, which manufactured the popular Candie's line, and then branching out on his own in 1982.

Nearly two decades later, when Cole expanded into apparel, he outsourced production to experienced Seventh Avenue manufacturers, through licensing agreements that gave them the right to produce merchandise bearing Kenneth Cole's name. "Kenneth was a shoe dog" said one apparel executive who knows him well. "He didn't know anything about ready-to-wear."

Despite that lack of experience, Cole was not shy about offering his input, sometimes to the chagrin of the people he'd hired to make his clothes. Liz Claiborne (Charts, Fortune 500), which held the license for women's wear from 1999 to 2005, struggled to come up with a line that would resonate with the department store customers it was trying to target and also meet with Cole's approval.

"Kenneth wanted everything too black, too tight and too sexy," said one person who worked with him.

Liz Claiborne has never divulged the details of its deal with Kenneth Cole (Charts), but a person familiar with the arrangements said the line never met its sales goals. When the license expired in 2005, Paul Davril, a Los Angeles company that held the rights to make men's clothing for Kenneth Cole briefly picked it up. Kenneth Cole has since taken back both the men's and women's licenses, a year before they were set to expire.

Other apparel firms, notably Polo Ralph Lauren, have taken back licenses in recent years to gain more control over the design and presentation of their products. But observers question whether Kenneth Cole has a deep enough management team to successfully navigate the transition. The risks are substantial. Under licensing agreements, the licensor is guaranteed a minimum royalty, even if sales fail to materialize. Going forward, Kenneth Cole won't have that safety net.

Meanwhile, plans to turn the Kenneth Cole New York label into a luxury brand have hit some snags. Cole envisioned the line as a designer alternative, selling at upscale department stores like Neiman Marcus, Nordstrom (Charts, Fortune 500) and Saks (Charts), as well as Kenneth Cole's own retail boutiques.

But Macy's (Charts, Fortune 500), one of Kenneth Cole's largest customers, balked and threatened to drop the lower priced Kenneth Cole Reaction brand if it did not get access to the more expensive line, sources said. Cole eventually acquiesced. While neither company would discuss the terms of the negotiations, Macy's spokesman Jim Sluzewski confirmed that the department store chain would start to carry the Kenneth Cole New York line this spring.

Overall sales of Kenneth Cole products have grown to $536 million in the most recent year, up from $85 million in 1994, the year the company went public. Sales have taken a nosedive for the first nine months of 2007, down 6 percent, including a 9 percent drop in sales to department stores, which still make up the majority of revenue.

The stock, which was trading at $19.13 Friday morning, is down 46 percent from a high of $35 last seen in June 2005. With no debt and nearly $5 a share of cash, rumors have swirled that Kenneth Cole could be the latest buyout candidate.

Though bankers broached the subject of a buyout within the past year, Cole was not interested, sources said.

Any deal would require Cole's approval. He controls 47 percent of the Class A stock and all of the Class B stock, which carry 10 votes per share.

That alone is incentive enough for him to want to fix the company's problems, even if it means handing the reins to an outsider. But anyone expecting a quick fix should think again.

On a recent Saturday afternoon at the Roosevelt Field mall, shoppers crowded into the Coach (Charts) store and grabbed at the latest handbag styles. Across the way, the sleek Kenneth Cole boutique sat empty. "The store is beautiful," said one passerby. "But no one's in there shopping."