By  on August 4, 2014

Michael Kors Holdings Ltd. may be losing a little of its Wall Street luster.

Shares in the fashion brand fell 5.9 percent Monday even though the firm reported a 50.2 percent increase in profits on a 43.4 percent gain in sales for the first quarter ended June 28. Analysts weren’t looking at the first-quarter numbers — they were more worried about the road ahead, including a projected decline in gross margins and operating margins going forward and concerns over the firm’s North American business.

Kors shares closed at $77.01. Nearly 21.7 million shares changed hands on Monday, compared with an average three-month trading volume of about 3.3 million.

Kors chairman and chief executive officer John D. Idol and chief financial officer Joseph B. Parsons fully addressed Wall Street’s worries on a conference call with analysts, but the explanations gave a somewhat mixed message as Idol also spoke about the “great runway for growth” overseas.

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Shares of Kors’ stock in the past two weeks have been up and down as research notes from analysts discussed possible gross margin pressures, not to mention questioning what appeared to be a higher level of markdowns in the stores, reports that Idol on the call labeled “incorrect.” For the three months ended June 28, net income rose to $187.7 million, or 91 cents a diluted share, from $125 million, or 61 cents, a year ago. Earnings per share beat analysts consensus estimate by 10 cents.

Total revenues increased to $919.2 million from $640.9 million, which included a 40 percent rise in wholesale net sales to $406.8 million and a 47.5 percent increase in retail net sales to $480.2 million. Comparable-store sales rose 24.2 percent in the quarter.

During the call, Idol spoke about how the brand’s North American business grew by 30 percent, fueled by an 18.7 percent comps gain, and that the extensions of categories such as footwear, women’s ready-to-wear and men’s wear will fuel incremental growth. As in the past quarterly conference calls, the ceo also spoke about growth opportunities: total store count possible in overseas geographic regions; conversion of wholesale doors to shops-in-shop; expansion in licensing of the watch, jewelry and fragrance categories, and bringing e-commerce in-house next month. Those are all viable opportunities that Idol said give the company a “long runway ahead of us to remain poised to deliver our long-term sales and earnings growth objectives.”

While Idol took issue with some analyst reports about the number of stockkeeping units on sale this year, stating that the company did not take a different position on markdowns inside the stores compared with a year ago, there were some reasons for concern.

On the call, Parsons said gross margin for the quarter expanded 20 basis points to 62.2 percent, reflecting a year-over-year rise of 63 basis points. That was driven by a geographic mix shift, but offset in part by a decrease of 48 basis points in its retail segment due to increased markdowns.

He later explained that while gross margin in the quarter expanded, the “margins are going to be impacted most by markdowns. So, the decrease was a markdown, but the beat [was] somewhat due to the strength of our European business, which as you know has a slightly higher margin.”

Operating margin in the company’s retail segment declined by 198 basis points, with 150 basis points due to an increase in retail operating costs, such as pre-opening rent expense. The balance was from a decrease in gross margin, the cfo said.

He also said that for the retail segment in fiscal year 2015, gross margin will likely fall by 50 basis points, while operating margins will decline 100 basis points due to continued investment in the company’s stores. Wholesale operating margin will expand 100 basis points, largely as a result of gross margin improvement overseas.

Idol said of the lower gross margin guidance, “[W]e don’t think that 0.5 percent is anything significant. We’ve always said that our margins are probably a little outsized both in gross margin and in operating margin somewhat because of the very, very, very quick sell-throughs that we had…”

He also noted during the question-and-answer period that the company brought in some merchandise early into the stores in late May and early June, which didn’t resonate well with consumers. And Idol disagreed with analysts who believe that the company is opening too many stores in North America. He said the firm will be “pretty much complete with our North American store rollout within the next 24 months or so.” Following that, the growth in North America will come from product extensions, he said.

During the call, analysts were also concerned that inventory would grow faster than sales, but company executives said this was necessary given the buildup in retail, not to mention investing more in inventory in Europe, such as replenishment, as that component of the Kors business becomes more focused on accessories, which is where the inventory cost is higher.

Jefferies analyst Randal J. Konik reiterated his “hold” on shares of Kors stock. “[O]ur key focus here remains on North America, where we are cautious of a slowing top-line momentum and margin pressure. [Michael Kors’] performance has been very strong to date, but the bar is very high and becoming increasingly difficult to surpass.”

Konik also noted that as “same-store sales growth slows on a one- and two-year basis, we continue to believe the brand is reaching a saturation point in the North American market.”

Sterne Agee’s Ike Boruchow has a “neutral” rating on Kors stock. Boruchow said that while the company’s top-line momentum and ability to manage earnings are impressive, “our concerns remain that inventories appear heavy. Gross margin pressure is looming and investment spend is picking up. Whether these ‘red flags’ are a tipping point in profitability remains to be seen; that said, we recommend remaining sidelined until we gain greater visibility.”

He also noted that operating margins were down 70 basis points in the quarter, representing the first decline since the company went public.

For the second quarter, the company forecasted diluted earnings per share in the range of 85 cents to 87 cents, on a revenue range of $950 million to $960 million. Analysts were expecting 89 cents on revenues of $959.5 million. For the full year, the firm guided diluted EPS at between $4.00 to $4.05 a share, on a revenue range of $4.25 billion to $4.35 billion.

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