By  on August 12, 2014

In the battle of the handbag firms, it was first all about market share. Now it’s about margins.

And Wall Street is worried. Shares of leading contemporary handbag brands have been battered over the last month, beginning with Michael Kors Holdings Ltd. and extending to Coach Inc. Kate Spade & Co. became the latest on Tuesday, even though the company posted a substantial narrowing of its second-quarter loss from a year ago.

Shares of Kate Spade plummeted 25.4 percent when investors looked ahead and decided they didn’t like possible margin pressures company executives noted during a conference call to Wall Street analysts. The decline in Kate Spade’s share price saw its market capitalization drop to $3.67 billion from $4.92 billion at the close of Monday’s trading session.

Shares of Kate Spade rose as much as 10.3 percent in early trading on Tuesday, hitting a 52-week high of $42.87 before they began to fall. The stock declined as much as 27.2 percent to an intraday low of $28.30, before closing at $29 in trading on the Big Board. More than 52.6 million shares changed hands, compared with an average three-month volume of nearly 1.6 million. The decline in Kate Spade shares impacted the entire sector, with Kors shares falling 3.2 percent to $77.44, and a 0.6 percent contraction at Coach Inc., to $35.98.

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To be sure, it’s been a volatile few weeks for handbag firms, beginning in mid-July with Michael Kors when analysts downgraded the stock in anticipation of its earnings report reflecting lower margins. The company’s executives did project a decline in gross margins and operating margins going forward, as well as concerns over its North American business. Then Coach Inc. reported earnings, and while margins were down slightly from a year ago, the concern there is whether the consumer will take to the new Stuart Vevers line next month.

In the case of Kate Spade, the company said the net loss for the three months ended July 5 was $4.4 million, or 3 cents a diluted share, compared with a net loss of $43.1 million, or 36 cents, a year ago. The company is largely finished with the wind-down of operations from the Juicy Couture business, which it sold a year ago. Kate Spade net sales for the quarter rose 48.7 percent to $266 million from $178.9 million.

Craig A. Leavitt, chief executive officer, said during the call that direct-to-consumer comps were up 30 percent and the company achieved comparable-store productivity of $1,477 a square foot over the last 12 months, marking the 16th consecutive quarter of annualized store productivity growth.

The company separated its reportable segment into two components, Kate Spade North America and Kate Spade International. The company’s Adelington Design Group is a separate reportable segment. By segment, Kate Spade North America saw net sales gain 54.6 percent to $208.4 million, while sales at Kate Spade International rose 53.6 percent to $49.2 million. Adelington posted a 30.6 percent drop in the period to $8.4 million.

For the six months, net income was $41.8 million, or 33 cents, against a net loss of $95.3 million, or 80 cents, a year ago. Net sales gained 46 percent to $489.6 million from $335.3 million.

While investors were initially pleased with results and revenue growth, their sentiment turned sour after Leavitt and George M. Carrara, chief financial officer, spoke about margins, coupled with a projection of a lower second-half comps range.

Leavitt spoke about the company’s migration in e-commerce for its core Kate Spade New York brand from flash sales to theme-driven sales, “which have a less-promotional posture and blend full-price and discounted products.”

But he noted that the largest impact on gross margin rate for the quarter was the “off-price sales margin primarily from the Kate Spade Saturday brand due to excess inventory and raw material disposal from prior seasons that were the result of a launched business that lacks scale.”

The ceo said the company is pleased with the “green shoots” of the business and while there is confidence in the value of the investment, it’s now a “larger investment with less improvement in the adjusted EBITDA [earnings before interest, taxes depreciation and amortization] margin” compared with plan at the beginning of the fiscal year.

And while the core Kate Spade retail business will still drive incremental adjusted EBITDA, it will be at a slightly lower margin rate compared with plan mostly due to unplanned rent increases for the Kate Spade stores relocating to former Juicy Couture sites, Leavitt said.

Carrara said the gross margin rate for the quarter fell to 58.6 percent from 61.8 percent, mostly due to liquidations of excess Kate Spade Saturday 2013 inventory. He said the current promotional retail environment, plus the impact of Kate Spade Saturday, now has the company expecting the full-year gross margin rate to decline by 125 to 175 basis points.

He also said there was a chance that the company’s profit margin goals could be extended by a year due to the investment in Kate Spade Saturday. Further, the cfo said “comps for the second half are planned in the high-single-digit range versus nearly 30 percent in the first half,” largely due to the shift in the comp-store base and earlier shift of the July 4th sales out of the second half.

In an interview with Leavitt, one bright note has been the ability of the company to increase traction with the aspirational consumer. Leavitt calls this the “splurge customer,” the shopper who spends more than $500 on a single item, buys multiple items and shops a few times during the year. “These are our most valuable customers....They are brand enthusiasts who are excited about the brand,” said the ceo.

He also noted that while a Hong Kong government statistic shows a 10 to 15 percent decline in May comps within the Asian city, the company so far has not seen that in sales of the Kate Spade brand in Southeast Asia, where it has a double-digit growth rate. Also doing well is Brazil, where it has the strongest comp rate globally among all of its regions, Leavitt said.

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